Broadcom's Earnings Call Remarks Suggest More Acquisitions Are On Tap

Though featuring a mixture of good and bad news for its two largest business segments, Broadcom’s (AVGO) latest earnings report and call didn’t do anything to raise major concerns about its long-term earnings growth outlook, and actually provided some useful color on how the chip giant sees things evolving.

This holds not only for Broadcom’s existing business, but also on the M&A front, where it looks as if the company is eager to move on from its thwarted bid for Qualcomm  (QCOM) and pursue new targets.

Broadcom reported January quarter (fiscal first quarter) revenue of $5.33 billion and adjusted EPS of $5.12, slightly topping consensus analyst estimates of $5.32 billion and $5.05. Revenue growth was officially 28%, and around 20% after backing out the impact of Broadcom $5.5 billion purchase of storage networking leader Brocade Communications (the deal closed early in the quarter).

April quarter revenue guidance of $5 billion (plus or minus $75 million) is in-line with consensus at the midpoint. Gross margin is expected to rise to 66% (plus or minus 1%) from a January quarter level of 64.8% (better than expected) and a year-ago level of 63.1%. Operating expenses, which grew 13% annually last quarter to $883 million (much less than revenue growth), are expected to rise slightly to $890 million before declining slightly in the following quarters.

Shares fell 2.2% in after-hours trading to $262.01, after having risen 2.8% in regular trading ahead of earnings. Though expectations weren’t all that high following light sales outlooks from Apple (AAPL) and many of its other chip suppliers, Broadcom’s in-line sales guidance might be disappointing some investors accustomed to seeing above-consensus forecasts.

Weighing on the guidance: Broadcom expects its Wireless Communications segment, which accounted for 41% of last quarter’s sales, to see a “much-larger-than-typical seasonal decline” due to a major sequential drop in shipments to Apple (referred to as “our large North American smartphone customer). The segment’s sales were up 88% annually last quarter to $2.21 billion (better than expected), thanks to the major increases seen in the dollar value of the Broadcom chips going inside the iPhone 8 and X relative to the iPhone 7.

On the bright side, Broadcom still sees wireless sales rising by a double-digit clip on an annual basis in the April quarter, thanks in part to Samsung’s Galaxy S9 ramp. CEO Hock Tan mentioned Broadcom is also seeing dollar content gains for the RF and Wi-Fi/Bluetooth chips shipping inside the S9 relative to the S8.

Notably, Tan was a little evasive when asked about dollar content growth for 2018 iPhone launches. He insisted Broadcom expects to continue seeing double-digit annual content growth over the next 3-to-5 years (growing RF complexity is a major driver), but declined to forecast 2018 growth.

Rival Qorvo’s (QRVO) shares jumped in January after the company signaled it expects 2018 iPhone content gains. Shortly afterwards, Nomura’s Romit Shah forecast Broadcom’s iPhone content will be $4 lower for this year’s models ($19 vs. $23). Qorvo sold off on Thursday thanks to a downgrade from BofA/Merrill’s Vivek Arya, who suggested iPhone share gain expectations are too high.

The shoe is on the other foot for Broadcom’s Wired Infrastructure segment (35% of revenue), which covers a number of products that go into enterprise/cloud data centers, carrier networks and living rooms. One one hand, the segment’s revenue fell 10% annually last quarter to $1.88 billion (worse than expected) due to soft Chinese optical demand and seasonal weakness for chips going into set-tops and broadband access hardware. On the other hand, “strong double-digit” sequential growth is expected this quarter, due to a seasonal broadband rebound and (more importantly) very strong enterprise and cloud data center demand. Both Intel’s (INTC) Xeon server CPU refresh and strong cloud capex are major tailwinds.

When asked about the long-term outlook for this segment, Tan suggested its data center-related sales (about half of the segment’s revenue) can grow around 10%, thanks in large to strong cloud demand for Broadcom’s market-leading Ethernet switching chip franchise (newer offerings, such as ASICs for AI workloads, are also helping). By contrast, the segment’s service provider-related sales, pressured by depressed telecom capex, are expected to be roughly flat.

Likewise, Broadcom is forecasting low-single digit long-term growth for its Enterprise Storage segment, which (with a lift from Brocade) accounted for 19% of January quarter revenue. Healthy demand for chips and cards related to storage controllers and solid-state drives (SSDs) will be partly offset by declining hard drive chip sales and limited Brocade growth.

But given Broadcom’s history of guiding cautiously, there could be some modest upside to its sales growth targets. And more importantly, the company looks well-positioned to keep growing EPS at a markedly faster clip than its organic sales. Margin expansion and spending discipline — see Broadcom’s GM and operating expense guidance — are part of the reason for this.

M&A, along with the big post-acquisition cost and pricing synergies Broadcom is able to reap, is of course the other reason. And it looks like Broadcom, just a few days removed from seeing the Trump Administration shoot down its attempt to buy Qualcomm, is ready to go acquisition-hunting again.

“Sitting here today, we do see potential targets that are consistent with our proven business model and that also can drive returns well in excess of what we would otherwise achieve buying our own stock and/or paying down debt,” said CFO Thomas Krause on the call. He added Broadcom is still aiming to return 50% of its free cash flow (FCF) via dividends, but prefers for now to save the rest for M&A.

Krause declined to specify just what kind of firms Broadcom is looking to buy as the chip industry continues consolidating. When asked if Broadcom would consider buying an analog chipmaker or microcontroller firm (among the companies that I think could be plausible targets), he didn’t quite say yes or no. “I think what I would say to this is we’re open, we’re open to looking at anything that helps,” he asserted. “One, [that] it is consistent with our business model, two, [that] it helps us drive the kind of returns well in excess of our alternatives.”

Higher chip industry valuations likely restrict just how many companies fit the second criteria. But there are still some sizable names that — like Broadcom, which trades for only 13 times its expected fiscal 2018 EPS — carry reasonable valuations. And it might not be long before Hock Tan & Co. go after one or two of them to provide fresh fuel for an earnings growth strategy that has been paying off quite nicely.

Jim Cramer and the AAP team hold positions in Broadcom and Apple for their Action Alerts PLUS Charitable Trust Portfolio. Want to be alerted before Cramer buys or sells AVGO or AAPL? Learn more now.

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