The Evolution of Broadcom
Following the fortuitous market climate of 2023, 2024 heralds a metamorphosis for Broadcom Inc. (NASDAQ:AVGO). With the long-anticipated acquisition of VMware (VMW) receiving the green light, a new era unfolds. Preceding 2024, sales tilted heavily (79%) towards semiconductors/hardware, with software comprising a modest 21%. However, the projected landscape of 2024 showcases a radical shift, with software expected to account for 40% – a pivotal juncture indeed.
The VMware deal has notably mitigated the risk posed by dependency on a handful of key customers, with the top 5 end customers contributing to 35% of net revenues and WT Microelectronics alone accounting for 20%. This maneuver proves particularly prescient in light of Apple’s potential exodus as a customer, given its foray into chip production. Although Apple remains tethered to Broadcom via a long-term contract, the capricious nature of the industry warrants circumspection. Nonetheless, bolstered by new revenue streams from VMware, Broadcom’s reliance on its top 5 customers is considerably assuaged.
The symbiosis between VMware’s mission-critical cloud software, which underpins myriad applications, and Broadcom’s portfolio appears auspicious. Moreover, in the realm of generative AI, wherein NVIDIA (NVDA) and VMware collaborate via VMware’s Private AI Cloud, leveraging NVIDIA’s CUDA software solution, Broadcom stands to benefit. This aligns with NVIDIA’s competitive edge over AMD, yet Broadcom is positioned to thrive, irrespective of the eventual victor in this contest. Anticipating a potential market share theft by AMD from NVIDIA? Dive into my recent article delving into this gripping saga of two GPU behemoths.
Broadcom, having transitioned from a hardware-centric entity to a semiconductor-focused one, is now poised to achieve equilibrium – a 50-50 split between software and semiconductor/hardware. Its extensive portfolio encompasses an array of inconspicuous electronic components that permeate daily life. The revelation that 99.9% of global Internet traffic traverses at least one Broadcom chip is nothing short of bewildering, underscoring its far-reaching influence – akin to a mammoth moat guarding its domain.
Embracing a pervasive ethos and profound industry acumen, Broadcom commands reliance from a multitude of clientele. Its dominance unfurls in the Wi-Fi domain, where nearly 80% of infrastructure banks on Broadcom, with 1 billion Broadcom DSL connections adorning the global landscape. Furthermore, a substantial portion of enterprise server customers entrust their server storage to Broadcom, drawn by its unwavering dependability, low latency, and power efficiency, all pivotal requisites for mission-critical operations. The company’s accentuation on software, particularly in the domain of data centers, is poised to reap dividends in the ensuing years.
Debt Dynamics and Financial Fortitude
A momentous uptick in net debt, from $25 billion to $70-80 billion, materialized following the VMware transaction. Notably, this surge aligns with Broadcom’s modus operandi – acquiring robust enterprises through leveraging debt, subsequently enhancing margins, and ultimately deleveraging the balance sheet. Historically, this blueprint has yielded resounding success for the company.
Personally, the prevailing debt magnitude exceeds my customary threshold. I typically favor companies with net debt not surpassing 4 times net income. However, with Broadcom’s net income pegged at a meager $14 billion in its latest financial disclosure, this yardstick falls short. Upon factoring in VMware’s prospective income in 2024, estimated to surpass $20 billion, the debt equation assumes a more palatable disposition.
Furthermore, Broadcom’s divestment plans for Carbon Black and EVC can potentially yield revenue, alongside a robust free cash flow of $17 billion. Parsing this, and accounting for SBC to the tune of $2.7 billion, we arrive at an SBC-adjusted free cash flow approximating $15.3 billion – ample to pacify shareholders, fuel expansion, and alleviate the balance sheet straits.
ROIC and Capital Allocation
Broadcom has masterfully wielded its stewardship over Return On Invested Capital (ROIC) in recent years, transmuting it from meager depths to an impressive 22%. Broaching the discourse on Broadcom’s Weighted Average Cost of Capital (WACC), estimated at approximately 9%, a robust ROIC-WACC spread of 13% ensues. This robust metric underscores Broadcom’s capacity for value creation, catalyzed by its M&A maneuvers and organic expansion. Conceivably, a marginal moderation in ROIC, during the initial one or two years post the VMware assimilation, is plausible, followed by an envisaged ascent.
