Broadcom Stock: Software As A Sustainable Revenue (NASDAQ:AVGO)

Broadcom Reports Quarterly Earnings

Justin Sullivan/Getty Images News

Since our previous coverage of Broadcom Inc. (NASDAQ:AVGO), the company’s stock price had increased above our previous target price of $517.95 driven by the robust performance of its semiconductor solutions and infrastructure software segments in 2021. They have grown by 18.05% and 6.74% YoY respectively. In Q1 2021, the company’s revenue grew by 16% YoY. Previously, we analyzed its semiconductor business and expect the company to benefit from agreement extensions with Apple for a total of $15bln. This should contribute positively to revenues, along with the expansion of its Wi-Fi 6 technologies, with a forecasted CAGR of 28% through 2025.

In this analysis, we focused on Brocade’s infrastructure software segments, which include key acquisitions such as Brocade, Symantec (Enterprise Security), and CA Technologies. Firstly, we examined the competitiveness of CA and its enterprise security business in terms of its market share and its customer base, which includes enterprise customers, and projected the segment’s growth based on the market forecast CAGR. Furthermore, as it introduced its new next-gen fibre channel products, we examined Brocade’s market positioning and projected its growth in this market. Lastly, in terms of profitability, we determined its infrastructure software segment’s margins to be superior to its semiconductor segment and identified its ability to redirect its focus on R&D while integrating the sales teams from its acquisitions.

CA and Symantec Security Businesses Leveraging Common Enterprise Customer Base

Based on the company’s annual report, Brocade’s Infrastructure Software segment has key products, including mainframe solutions from its CA Technologies acquisition. This consists of security and infrastructure management solutions and BizOps software solutions. Further, the Symantec Enterprise Security acquisition also provides cybersecurity offerings. While both acquisitions provide distinct product offerings, we believe the common aspect of these acquisitions is similar target customers which are large scale enterprises. For example, according to its annual report, large enterprise customers, including most of the Fortune 500 companies, use CA software for their hybrid clouds.

According to Broadcom, customers using its Mainframe Application Development, Quality and Testing Tool solutions benefit from cost savings of $2.1 mln on average over a 5-year period. We believe this could be one of the factors to explain its popularity among enterprise customers, as over 70% of the top 30 largest companies utilize its Mainframe DevOps solutions. As seen in the chart below, Broadcom is the market leader in the application development & management tools and mainframe database markets.

application development and infrastructure software market share

Gartner, IDC

In addition to mainframe software, the company has also boosted its enterprise security portfolio with Symantec in endpoint protection, data loss prevention, and secure web gateway. Broadcom’s CEO Hock Tan previously highlighted that this acquisition expands its footprint of infrastructure software for Global 2000 customers. Its cyber security software solutions span across endpoint, network, information and identity security. In terms of market share, Symantec Enterprise Security had a 16% share in endpoint security and sits comfortably in the web security and DLP markets.

enterprise endpoint market share

Broadcom

As we see Broadcom continuing to integrate solutions from CA with its enterprise customers and as an established market leader, we projected its CA business revenues based on the forecasted weighted application and system infrastructure market CAGR.

Application and System Infrastructure Markets

Market Size ($ bln)

Weight

CAGR

System Infrastructure

143

47.5%

3.67%

Application Development

158.1

52.5%

8.51%

Weighted CAGR

301.1

100%

6.21%

Source: Statista, Khaveen Investments

Moreover, we forecasted its Symantec revenue growth rate based on the forecasted global enterprise cybersecurity market CAGR. We then derived a weighted average growth rate for the total infrastructure segment, including CA and Symantec, based on our previous estimated revenue breakdown between CA and Symantec from our previous analysis.

Acquisition

Revenue ($ bln)

Weight

CAGR

CA

3.5

68.6%

6.21%

Symantec

1.6

31.4%

8.90%

Total

5.1

100.0%

7.05%

Source: Broadcom, ResearchReportsWorld, Khaveen Investments

Thus, we applied our weighted average growth rate forecast for CA and Symantec revenues in the table below.

Revenue Forecast ($ bln)

2020

2021

2022F

2023F

2024F

2025F

2026F

CA and Symantec

5.1

5.34

5.72

6.12

6.55

7.01

7.51

Growth %

4.7%

7.05%

7.05%

7.05%

7.05%

7.05%

Source: Broadcom, Khaveen Investments

Overall, we believe the acquisitions of both companies provide potential cross-sell opportunities between its combined application development and infrastructure software portfolio among its enterprise customers. For example, customers using its Mainframe Application Development solutions could use its mainframe security product portfolio to prevent cyberattacks and ensure the security of its enterprise data. Additionally, in the company’s Software Investor Day, the company highlighted its complementary portfolio with 80% of its customers licensed to 5 or more of its software solutions.

Leveraging Brocade for 64G Fibre Channel Product

In 2021, the company introduced the world’s first 64G Fibre Channel HBA for customers to implement an end-to-end 64G data path. The product integrates Broadcom’s optics portfolio with Brocade’s Fibre Channel switches as well as Emulex Fibre Channel HBAs. Additionally, the company recently launched a double density 64G Fibre Channel optical transceiver.

Brocade by itself is already a strong market leader, with a portfolio that includes FC SAN products incorporating multiple semiconductor products as well as software-based management tools. It has an 82.5% market share of the SAN market. According to BlocksandFiles, Fibre Channel is a high-speed networking technology that links servers and SANs and performs twice as fast as the current-gen 6 standard’s 32Gbit/s with 50% lower latency. Based on the chart below, the majority of the market is still on the previous-gen (32G), which we believe highlights the market opportunity for the switch towards 64G products.

fiber channel market

Broadcom

Compared to Broadcom’s competitors in the chart below, the company has a comprehensive portfolio in server storage connectivity, with products spanning across storage, ethernet, PCIe and Fibre Channel from Brocade. In comparison, Intel (INTC) and Mellanox’s (Nvidia) (NVDA) portfolio focuses on ethernet, while Microsemi on storage and PCIe as well as QLogic on Fibre Channel. Thus, we believe this provides unique portfolio integration opportunities to the company as seen with the introduction of its 64G Fibre Channel HBA.

server competitors

Broadcom

Overall, we forecasted the company’s FC SAN revenues based on the market CAGR of 10.30% through 2025. In total, we projected its infrastructure software segment revenues to grow at an average rate of 7.9% over the next 5 years, which is also in line with management expectations of mid to high single-digit growth. Also, in its latest earnings briefing, the company’s management mentioned its Software backlog increased by over $15 bln compared to $13 bln in the prior year.

Infrastructure Software Segment Forecast ($ bln)

2020

2021

2022F

2023F

2024F

2025F

2026F

CA and Symantec

5.1

5.34

5.72

6.12

6.55

7.01

7.51

Growth %

4.7%

7.05%

7.05%

7.05%

7.05%

7.05%

Brocade

1.52

1.73

1.91

2.10

2.32

2.56

2.82

Growth %

13.6%

10.30%

10.30%

10.30%

10.30%

10.30%

Total Infrastructure

6.62

7.07

7.62

8.22

8.87

9.57

10.33

Growth %

6.7%

7.8%

7.9%

7.9%

7.9%

7.9%

Source: DigitalJournal, Broadcom, Khaveen Investments

With the introduction of its next-gen fibre channel products, we expect the company’s growth through its Brocade acquisition to benefit from the growth of the fibre channel market and as an established leader in this market.

Acquisition Integrations Support Infrastructure Software’s Profitability

Another strength of Broadcom’s infrastructure software segment is the superior profitability of the segment with an operating margin of 69.8% in 2021. Broadcom had also sliced and diced some business segments of its acquired companies and retained its profitable business units. For example, CA Technologies’ mainframe solutions in 2018 had operating margins of 64%, indicating the lucrative business model that has held onto many of its major enterprise accounts compared to its enterprise solutions segment, which had margins of around 9%. We compiled the operating margins of CA Technologies, Brocade and Symantec in the year prior to its acquisition, which shows the lower margins compared to Broadcom’s current infrastructure software segment.

Pre-acquisition Operating Margins

Operating Margins %

CA Technologies

28.12%

Brocade

13.09%

Symantec

18.52%

Broadcom (Infrastructure Software)

69.8%

Source: CA Technologies, Brocade, Symantec, Khaveen Investments

Besides that, we believe another key opportunity for Broadcom is to integrate its acquired companies selling & admin operations with its sales force and provide an opportunity to leverage Broadcom’s existing relationships with key enterprise clients. We believe this allows the company to redirect its focus on R&D to further develop and enhance its software to cater to evolving demands of its clients. As seen with its software infrastructure segment in 2021, its SG&A expenses as a % of revenue declined as it increased its R&D spending.

Broadcom Infrastructure Software Segment ($ mln)

2020

2021

Change %

Operating Expenses as % of revenue

21%

19.6%

-1.4%

R&D expenses as % of revenue

12%

12.2%

0.2%

SG&A expenses as % of revenue

9%

7.4%

-1.6%

Source: Broadcom

To sum it up, we believe the company’s infrastructure software segment margins could benefit from potential upside as the company integrates its acquisitions and targets a common customer base which is enterprise customers. Through the integration of its sales force, we expect the company to generate synergies translating to lower SG&A spending as a % of revenue and direct its resources to R&D activities to enhance its capabilities.

Risk: Debt Levels Concern to Acquisition Strategy

While Broadcom pursues growth through acquisition strategy, the company’s debt levels have significantly risen over the years, which could hinder its ability to acquire companies. In 2020, its net debt stood at $37.33 bln, which represents around 15.6% of its market cap. This is an increase of almost 631% in the past 8 years.

Net Debt (Net Cash) ($ mln)

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

Debt

193

251

6,733

5,184

26,829

30,127

22,656

41,668

51,196

49,495

Cash & Cash Equivalents

1,084

1,008

1,628

1,822

3,097

11,204

4,292

5,055

7,618

12,163

Net Debt (Net Cash)

(891)

(757)

5,105

3,362

23,732

18,923

18,364

36,613

43,578

37,332

Cash to Debt Ratio

5.62

4.02

0.24

0.35

0.12

0.37

0.19

0.12

0.15

0.25

Source: Broadcom

Additionally, its interest coverage has deteriorated at the same time but remains positive from 14.5x in 2014 to 7.9x in 2021.

Recently, the company announced its acquisition of AppNeta for an undisclosed sum. It is relatively small in comparison to its acquisitions of CA, Brocade, and Symantec Enterprise Security, with an estimated revenue of only $24.2 mln, according to Growjo.

Overall, we believe the rising debt profile of the company could pose a risk for it to acquire larger companies and complement its growth strategy around software as it aims to become a stronger infrastructure technology company.

Valuation

The company had a 5-year average revenue growth rate of 16.09%, inclusive of acquisitions. We expect margins to rise as the company realizes cost synergies from its infrastructure software segment, which also commands superior gross margins than its semiconductor solutions segment.

broadcom earnings and margins

Broadcom, Khaveen Investments

In terms of cash flows, the company had a 5-year average FCF margin of 15.24% and is volatile due to the series of acquisitions it made. In our forecast, we assumed its capex assumption, excluding acquisitions, at a 5-year average capex as % of total revenue of 2%, as we had not factored in M&A revenue forecast contribution in our projections.

broadcom cash flows

Broadcom, Khaveen Investments

We valued the company based on a DCF analysis, as the company has strong cash-generating abilities. For the terminal value, we used a weighted EV/EBITDA based on the chipmaker companies, with an average of 24.15x.

industry average EV/EBITDA

Seeking Alpha, Yahoo Finance, Khaveen Investments

We projected its revenues according to its semiconductor and infrastructure software segments as discussed above. For the semiconductor segment, we based our forecast on the semiconductor market’s past 19-year average growth rate of 8.15%.

Broadcom Revenue Projections

2020

2021F

2022F

2023F

2024F

2025F

2026F

Semiconductor Solutions

17,267

20,383

22,043

23,839

25,780

27,880

30,151

Semiconductor Solutions Growth %

18.05%

8.15%

8.15%

8.15%

8.15%

8.15%

Infrastructure Software

6,621

7,067

7,622

8,221

8,869

9,570

10,329

Infrastructure Software Growth %

6.74%

7.85%

7.87%

7.88%

7.90%

7.92%

Total Revenue

23,888

27,450

29,665

32,060

34,650

37,451

40,480

Total Growth %

14.9%

8.1%

8.1%

8.1%

8.1%

8.1%

Based on a discount rate of 9.2%, our model shows that its shares are undervalued by 38.93%.

broadcom valuation

Khaveen Investments

Verdict

We analyzed the company’s infrastructure software segment, which consists of its Brocade, CA Technologies and Symantec Enterprise Security segments. Catering to a common customer base of enterprise customers, we believe this provides cross-selling opportunities for its application development, infrastructure system software and enterprise security solutions.

We expect CA and Symantec Enterprise Security revenues to grow steadily at a CAGR of 7.05%. Moreover, for Brocade, we expect the company to benefit as an established market leader and with the introduction of its next-gen 64G product as a tailwind to growth. In total, we see its infrastructure software segment continuing to grow, with an average growth rate forecast of 7.9%.

Finally, we analyzed its segment profitability which commands superior operating margins of 69%, and believe the integration of the acquisition salesforce could provide synergy opportunities and enable it to channel resources towards R&D to enhance its capabilities. Overall, we rate Broadcom as a Strong Buy with a target price of $813.84.

Be the first to comment

Leave a Reply

Your email address will not be published.


*