Betting on Broadcom's Resurgence

 | Dec 22, 2011 | 4:30 PM EST  | Comments
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When I followed Broadcom (BRCM) in the early 1990s, it was the envy of Silicon Valley. Under hard-charging co-founder Henry Nicholas, the company was known as a "slave ship with options." Engineers toiled long the night working under seemingly impossible deadlines to deliver some of the most innovative semiconductor designs ever invented.

Now, with the stock down sharply in 2011, is it time to get in or should investors look elsewhere?

Broadcom is one of the best semiconductor designers on the planet. For example, in 2007, the typical 10-gigabyte Ethernet switch had as many as 53 Broadcom chips and offered 48 10-gigabyte ports. By 2011, the company squeezed the 53 chips down to a single chip. The same switch now offers 64 ports, 60% lower power consumption and is 30% less expensive. Not too shabby.

Broadcom engineers are able to achieve these amazing designs by playing to the company's strength in systems integration (also called "system on a chip" or SoC). In other words, the company excels at taking many different systems and squeezing them down to a single slice of silicon. A smartphone, for example, has half a dozen disparate systems. Inside the tiny case, all smartphones have a 2G/3G or 4G modem, an application processor, a bunch of chips to run the display, Wi-Fi, Bluetooth, and power-management chips. Broadcom excels at shrinking these pieces down into a single chip, thereby saving space, power and, most important, cost.

As consumers adopt new technologies, unit volumes and competition increase. Manufacturers look for ways to cut costs. Broadcom wins "sockets" by using its SoC skills. A high-end smartphone might have an average bill of materials of $183 and uses dozens of chips. But by selecting a Broadcom design, a manufacturer can cut the bill of materials to between $90 and $125. When you're locked in global hand-to-hand combat with other handset makers cranking out millions of phones, a 40% savings on your semiconductor bill is a big deal.

One of the reasons Broadcom has been so successful with its SoC strategy is because the company has been on an aggressive acquisition spree since the mid-1990s. By acquiring small specialty chipmakers, Broadcom has been able to integrate new technologies quickly. For example, a semiconductor company might make a great 4G radio or a great video processor or great power-management chip, but doesn't have all those designs under one roof. Because of past acquisitions, Broadcom is able to integrate all these technologies onto one chip. When it needs video compression technology, it turns to one division. When it needs power management, it turns to another. And when it needs Ethernet or data storage expertise, it turns to yet another division.

Other semiconductor companies have a "not invented here" strategy. Not Broadcom; it quickly acquires the needed expertise and integrates that knowledge into the rest of the company's designs. In that way, Broadcom is able to jump from one hot growth area to another. When the cable modem business slowed, it was able to jump to data storage. When storage slowed, it jumped to networking. Today, more than half its revenues come from communications, and the company is quickly winning sockets in some of the hottest smartphones. In the Android space, Broadcom has won virtually every socket in Samsung's smartphone lineup.

Year-to-date, the stock has lost a third of its value. Investors fled when they that realized sales in fiscal 2012 would grow just 2.2% vs. nearly 10% in 2011. Broadcom, like other tech makers, hasn't been able to escape global economic uncertainty. But if you believe that economic clouds will lift in 2012 as Europe straightens itself out, Broadcom could be an interesting buy here.

In October, Broadcom posted third-quarter results of $0.48, well below Street estimates of $0.60. The lower-than-expected earnings were the result of lower operating margins as the company was hurt by large legal bills and higher expenses from junking its digital TV/Blu-Ray business. More importantly, the company's mobile and wireless business has taken off. While sales at the rest of the company rose 9%, the wireless business rose 16%. Operating margins should stabilize (50% to 51%) and the top line should begin to reaccelerate as wireless becomes a larger percentage of overall revenues.

Investors looking for a depressed semiconductor play should consider Broadcom.

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