AI Accelerators And VMware Revamp Fuel Semiconductor Success

Key Takeaways

• AI revenue growth and custom AI accelerators position Broadcom for increased market share in the AI sector, bolstered by securing significant customers.
  
• Strategic R&D investments and operational efficiency improvements suggest a bright outlook for semiconductor revenue and enhanced shareholder returns.
  
• Broadcom's shift towards AI and reliance on key hyperscale customers, alongside the financial risks from the VMware acquisition, could significantly affect its revenue and financial stability.

Catalysts

Designs, develops, and supplies various semiconductor devices with a focus on complex digital and mixed signal complementary metal oxide semiconductor based devices and analog III-V based products worldwide.

• AI revenue growth and expansion into custom AI accelerators indicate a potential increase in revenue and market share in the AI semiconductor sector, further strengthened by securing three significant customers for these accelerators.
  
• The ongoing transformation of VMware and its shift towards a subscription-based model, particularly with VMware Cloud Foundation, suggests an increase in stable, recurring revenue and an improvement in net margins due to cost reductions and efficiency improvements in this segment.
  
• Broadcom’s strategic investments in semiconductor R&D, especially in networking and AI, hint at future revenue growth from new products and technologies, supporting a positive outlook for semiconductor revenue, particularly as non-AI networking shows signs of recovery.
  
• The reduction in VMware operating expenses and the targeted EBITDA goal exceeding expectations for the next fiscal year indicate operational efficiency and margin improvement which could contribute to an uplift in the company’s valuation.
  
• Broadcom's disciplined approach to capital allocation, including dividend payments and debt reduction, enhances shareholder return and improves the company’s financial stability, potentially making the stock more attractive to investors looking for stable, long-term performance.

Assumptions

• Analysts are assuming Broadcom's revenue will grow by 17.0% annually over the next 3 years.
• Analysts assume that profit margins will increase from 11.7% today to 41.7% in 3 years time.
• Analysts expect earnings to reach $31.2 billion (and earnings per share of $6.91) by about November 2027, up from $5.5 billion today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 35.6x on those 2027 earnings, down from 140.7x today. This future PE is greater than the current PE for the US Semiconductor industry at 30.1x.
• Analysts expect the number of shares outstanding to decline by 1.08% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.35%, as per the Simply Wall St company report.

Risks

• A continued pause in telco and service provider spending could cause further declines in broadband revenue, adversely affecting overall revenue growth.
  
• The focus on AI and custom accelerators may lead to significant R&D and operational expenses, potentially compressing net margins if these initiatives do not generate expected returns.
  
• The high dependence on a few hyperscale customers for AI and custom accelerator revenue introduces concentration risk, where loss or reduced spending by any of these customers could significantly impact revenue.
  
• The shift in strategy towards AI and VMware integration requires high execution risk, where failure could impact earnings due to increased costs and missed revenue opportunities.
  
• The heavy debt burden from the VMware acquisition and related restructuring poses a risk to financial stability, potentially impacting net income and cash flows if interest rates rise or if profitability wanes.

Valuation

• The analysts have a consensus price target of $193.49 for Broadcom based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $240.0, and the most bearish reporting a price target of just $155.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $74.9 billion, earnings will come to $31.2 billion, and it would be trading on a PE ratio of 35.6x, assuming you use a discount rate of 8.3%.
• Given the current share price of $165.35, the analyst's price target of $193.49 is 14.5% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.