Broadcom’s Growth Potential: Diversification, 5G, Cloud Migration, And VMware Acquisition

As a standalone company, Broadcom Inc. (NASDAQ:AVGO)’s diversification and market opportunities have allowed AVGO to return strong financial performance over the years and I believe this advantage would continue in the foreseeable future leading me to value the shares at $581. However, the potential acquisition of VMware (VMW) could add benefits such as enhanced hybrid cloud computing, network function virtualization, security, and end-user computing products, increasing the value per share anywhere from $80 to $187. In this article, I will discuss AVGO’s market opportunities, growth drivers, diversification, competitive advantages, financial performance, and growth prospects. Furthermore, I will explore the pending acquisition of VMware and its potential impact on the combined entity’s value and offerings.

Company Overview

AVGO is a leading designer, developer, and supplier of a broad range of semiconductor and infrastructure software solutions. Its product portfolio serves the data center, networking, software, broadband, wireless, and storage markets. AVGO’s key offerings include data center switches and routers, set-top/CMTS, cable modems, Wi-Fi, Bluetooth, and wireless solutions. AVGO has expanded its software portfolio through strategic acquisitions of CA Technologies, Symantec’s enterprise security business, and a pending deal to acquire VMware.

Market Opportunities and Growth Drivers

The two main market opportunities for AVGO I see are based on the 5G Wireless Infrastructure and cloud migration.

As 5G networks become more widespread, stakeholders are facing challenges related to transmission losses in electronic components such as 5G antennas, filters, circulators, cables, and wirings. This has led to a growing demand for high-performance materials with low-loss properties.

The rapid progress of 5G technology worldwide and its increasing adoption rate are expected to create significant growth opportunities for the RF filters market in the coming years. AVGO is a leader in this market segment.

AVGO’s FBAR filters are top-notch, with superior performance, making them stand out in the market. As 5G smartphones require more advanced filters in greater quantities, AVGO’s expertise and unique manufacturing process give them a competitive advantage in this expanding market.

By 2025, more than half of the IT spending in software, infrastructure, business process services, and system infrastructure markets will have shifted from traditional solutions to the public cloud. The COVID-19 pandemic has further accelerated this shift toward cloud adoption.

This trend has increased demand for data center switches and routers as workloads continue to move from on-premise data centers to the cloud.

Diversification and Competitive Advantage

AVGO has positioned itself as a market leader in several segments, including data center switching and routing, set-top box solutions, RF filters, and Wi-Fi/Bluetooth connectivity chips. This diverse set of profitable business lines provides AVGO with a robust revenue stream and a competitive edge in the technology landscape. AVGO’s strategic acquisitions of CA Technologies in 2018 and Symantec’s enterprise security business in 2019 have significantly bolstered its software offerings.

Financial Performance and Growth Prospects

AVGO has consistently delivered strong financial performance, with robust top-line growth and profitability. This demonstrates AVGO’s ability to generate solid cash flows and maintain healthy margins across its diverse set of businesses.

AVGO’s diverse revenue streams, including semiconductor solutions and infrastructure software, provide stability and growth potential.

Pending Acquisition of VMware

AVGO has agreed to extend the deadline for its $61 billion acquisition deal of VMware by 90 days. The new final date for the deal is set for May 26, 2023, as both companies continue to progress with regulatory authorities. Delays might be due to clearance from anti-trust and competition watchdogs in the US, UK, and EU. Although concerns have been raised about AVGO’s track record with previous acquisitions like CA Technologies and Symantec, both companies have since attempted to reassure customers.

The potential acquisition aligns well with AVGO’s strategy, as it enables them to focus on large multinational clients who use private and multi-cloud environments. With over 5,000 patents, VMware has a solid foundation that can strengthen AVGO’s position in the tech industry. The deal is expected to provide AVGO with around $8.5 billion of pro forma EBITDA contribution. As the virtualization market continues to expand, the acquisition would solidify VMware’s already strong presence in private cloud infrastructure.

The combined entity would benefit from VMware’s focus on making its products available as SaaS offerings, potentially expanding its technology portfolio in areas such as virtualization, NFV, NSX networking software, and 5G support. Synergies may also exist in the development of smart NICs environments and multiple product integrations. However, concerns remain regarding potential price increases for customers and the impact on VMware’s innovation under AVGO’s ownership.

The acquisition would allow AVGO and VMware to provide enterprise customers with a broad range of innovative solutions, thanks to VMware’s impressive cloud-neutral software that complements AVGO’s offerings perfectly.

Although a successful acquisition would temporarily increase AVGO’s leverage, AVGO has repeatedly demonstrated its ability to deleverage after an acquisition.

Valuation

After conducting a DCF analysis, I have valued the shares of AVGO as a standalone business at $581 per share. This valuation is based on a cost of capital of 9.9%, which was derived from an unlevered beta of 1.53 for the semiconductor industry.

For revenue growth, I have assumed the growth drivers mentioned earlier in this article. As for margins, I anticipate a slight improvement. Here are the remaining assumptions:

Keep in mind that the acquisition cost is $69 billion as it includes $8 billion of assumed debt.

Management guided that the VMware transaction would bring $8.5 billion of proforma EBITDA. This would imply that this deal could add up to $187 value per share depending on whether AVGO’s share would rerate closer to VMware’s multiple. I believe the proforma EBITDA would be 30% lower than guidance and that the shares would trade close to 16x implying the value added per share to be $80.

If you trust management’s guidance and believe that this transaction will close, the share value could reach $706 to $768. I think the synergies might be slightly lower than expected, resulting in a target price of $661 per share. The combined company’s size and new offering should warrant a margin expansion, closer to VMware’s 17.3x multiple.

Currently, the market is assigning a 74% chance of the transaction closing or it is implying the proforma EBITDA to be 30% lower than management’s guidance.

Conclusion

AVGO’s diversification and market opportunities have contributed to its strong financial performance over the years. This advantage is expected to continue in the foreseeable future, leading to a standalone share value of $581. However, the potential acquisition of VMware could bring additional benefits such as enhanced hybrid cloud computing, network function virtualization, security, and end-user computing products, increasing the value per share anywhere from $80 to $187. Throughout this article, I have discussed AVGO’s market opportunities, growth drivers, diversification, competitive advantages, financial performance, and growth prospects. Additionally, I have explored the pending acquisition of VMware and its potential impact on the combined entity’s value and offerings. The market currently is assigning a 74% chance of the transaction closing, or it implies the proforma EBITDA to be 30% lower than management’s guidance. I believe the truth lies somewhere in between; while I believe the transaction will close, the proforma EBITDA may be lower than guided, and I estimate the fair value of the shares to be $661.