Broadcom Inc.

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 3/5

A global technology leader that designs, develops, and supplies a broad range of semiconductor and infrastructure software solutions.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Broadcom, often called a “fabless” semiconductor company, designs its chips, but outsources their production to third-party manufacturers. This allows Broadcom to focus on designing innovative products while offloading the capital-intensive process of manufacturing.

Business Overview

Broadcom operates in two primary segments: Semiconductor solutions and Infrastructure software.

  • Semiconductor Solutions: This segment encompasses a broad range of wired infrastructure semiconductor solutions, including networking products, broadband access solutions, set-top box components, wireless connectivity (Wi-Fi and Bluetooth) and other custom application-specific integrated circuits (ASICs). Broadcom is a leading supplier of chips for networking, connectivity, and industrial applications, and operates in a highly competitive field. The demand is driven by growth in cloud computing, AI, and the need for increased data transmission capacity, but has significant swings given that the main customer base is large data centers and hyperscalers.
  • Infrastructure Software: Broadcom offers software solutions across cloud, data center, and enterprise environments, including security, mainframe, automation, and compliance software, and the overall business goal of the software business is to maintain market shares and continue to generate recurring revenue from its base. This segment provides mission-critical infrastructure software that helps enterprises secure, manage, and optimize their IT environments. The main reason behind this segment is to stabilize the revenue in comparison to the semiconductors that tend to be more volatile.
  • Semiconductor Industry: Characterized by high complexity, fast technological advancement, and considerable cyclicality. Increasing global demand for semiconductor chips from industries, including automotive, data centers, and consumer electronics. Strong IP is critical to maintaining a competitive advantage and is often protected through patents. The sector also is currently experiencing rapid growth for AI-related chips.
  • Software Industry: Rapid technological advancements and the demand to digitize operations. It is also a subscription-based industry where many companies are using cloud solutions. Customers prefer software that offers scalability, security, and reliability. Cyber security threats remain a real problem for businesses and will only increase over time.
  • Macroeconomic Headwinds: The global economy is facing turbulence, and the uncertainty caused by macro factors will affect both the semiconductor and software industries to some extent. High inflation, interest rates, geopolitical uncertainty, and changes in trade policy can create headwinds for technology companies in the coming years.

Competitive Landscape

Broadcom has exposure in many different markets and is facing a diverse competitive landscape, these are some of the major competitors:

  • Semiconductor Solutions: Competitors include Intel, AMD, Nvidia, and Broadcom’s previous competitor Qualcomm in various segments. These competitors are formidable and are well-funded as well. Some smaller companies exist too but they have difficulty in achieving the same level of scale.
  • Infrastructure Software: Competitors range from large tech companies, such as IBM, Oracle and Microsoft, to smaller specialized software vendors.

While Broadcom is a very large player and a leader in the semiconductor industry, the main challenges they face is the ever changing dynamics in the tech world. It might be difficult for Broadcom to keep up with the newest trends and technologies in their fast paced industry.

Financials

Broadcom’s financial results have been a mixed bag recently. While revenues have generally grown, profitability in certain areas has declined: Revenue: Broadcom’s revenues have had a steady increase in the past couple of years, as more products have been released for their different segments. They posted revenue of $8,751 million in Q3, representing 5% year-over-year growth. Full-year fiscal 2023 revenue was $35.8B, a 6.7% YoY increase.

This level of revenue growth is a far cry from past performance when revenue grew by more than 10%, which has caused some apprehension over future forecasts.

  • Margins: Gross and operating margins have been under pressure in recent years, mainly due to increased competition and increased costs, partially related to integration costs from VMware acquisition, but the company has shown a resilience to retain good margins. The average gross margin for fiscal year 2023 is 74.9% and the operating margin is 49.3%. This is a strong result compared to most other companies.
  • Cash Flow: The company is still a strong cash flow generator with cash from operations at $16.9 billion in fiscal year 2023, a decent result, although it is slightly lower than previous periods, and free cash flow is 45.9% of total revenue. The main concern here is how to deploy the cash in an efficient way to bring long term returns for shareholders.
  • Capital Structure: In recent years, Broadcom has been using debt to finance acquisitions, including most importantly, the acquisition of VMware, which means that the company’s liabilities are significantly higher now than they previously were. As of November 5, 2023, Broadcom’s cash balance was at $12.6B and long-term debt at $66.9B. In order to mitigate that high debt, the company has been repaying a lot of the debt.
  • Capital Allocation: The company’s capital allocation policies are aggressive given their increased debt level, and the main use of capital is share buybacks and dividends to shareholders, rather than reinvesting more in growth. In 2023, Broadcom authorized a $10 billion share repurchase program, paying $7.1 billion in cash dividends.

Broadcom’s financial strategy to enhance returns through buybacks and dividends, may have adverse effects in the long run, and has put the company in increased risk. The combination of high debt and the lack of growth in revenue has made investors wary over investing in AVGO.

Moat Assessment

Based on the analysis and understanding of the business, I would rate Broadcom’s moat at 3 out of 5. Here is the breakdown:

  • Intangible Assets (Brands, Patents, etc.): Broadcom holds many valuable patents on key tech in the various sectors in which it competes. It also has some strong brands in areas such as Wi-Fi. Although, as mentioned before, it’s difficult to predict how long patents may last given the ever-changing dynamic in the tech industry.
  • Switching Costs: Parts of Broadcom’s business are embedded directly into customers operations (such as semi-conductor solutions) but the infrastructure solutions can have higher switching costs, because of the complexity of the enterprise environment.
  • Network Economics: Some parts of the software business also benefit from the network effect, which could prove a valuable moat for the company.
  • Cost Advantages: Broadcom has a small cost advantage due to scale in design and distribution, especially in the semi-conductor division.

Justification: Broadcom has some competitive advantages that can help them fend off new competition, but they may not be lasting. Their business is still highly dependent on the underlying performance of their customer’s businesses, as well as being very cyclical, especially in the semiconductor division. The business model is difficult to fully understand, and because of their financial structure, the company is more vulnerable than it was a couple of years ago. While the company is very big and a key player in its field, the advantages it has are not as strong as to warrant a “wide moat” rating.

Risks to the Moat & Business Resilience

  • Technological Disruption: Given the rapid pace of technological innovation, Broadcom faces the ongoing threat of disruption and obsolescence. Changes in technology and the emergence of new standards can quickly diminish the company’s competitive advantage or make legacy products obsolete.
  • Increased Competition: The various sectors in which Broadcom operates are hotly contested with new entrants trying to break the hold of existing players, which means increasing competition is a real threat. This can negatively affect both sales and margins of the company.
  • Macroeconomic Environment: The various macroeconomic headwinds, such as high inflation and interest rates can make it difficult for Broadcom to operate. Furthermore, the high debt means they will be impacted severely during a recession.
  • Customer Concentration: As a fabless manufacturer, the supply chain is key. Many of Broadcom’s revenues come from a limited number of large customers, which could result in substantial losses if those contracts are terminated. They are heavily dependent on their few but large customers for the revenue.
  • Integration Risks: The VMware acquisition brings integration challenges. The company will have to work through large integration costs in order to reach the synergies they have in mind.
  • Financial Leverage: A high debt load may constrain the company’s operational agility and make them more risk averse. The interest rate environment is also impacting debt, and the company will have to be disciplined in their financing for long term success.

Business Resilience: Broadcom shows good resilience because of its high moat, and its diverse business structure which means that one division performing worse, could be supplemented with another. The company has always managed to come back from setbacks and has proven management’s ability.

Understandability

Given the nature of the business, it is not easy to grasp everything the company does, and how all its divisions function together. Given their wide product portfolio and the different segments they have, this is not a company that is the easiest to analyze and fully understand without having some prior expertise. This warrants a 3/5 rating.

Balance Sheet Health

Broadcom’s balance sheet is at a very important position, their debt is very high right now because of recent acquisitions, but their current assets are solid. Although the company has been reducing debt, the current level remains high and presents a threat to the business. Because of these reasons, I have rated the balance sheet health at 3/5.

In Summary:

Broadcom is a company with an impressive history, as they have been a key player in the technology industry, and generate a lot of value, but are facing new challenges that need to be addressed in the coming years. The company is at an important stage, as they are going through a transformative period with the VMware acquisition and will need to focus on maintaining and creating economic value. They should also be cautious over their debt load.