Navigating Growth And Innovation, A Calculated Outlook On VMware's Integration And AI Expansion

Key Takeaways

• VMware integration and AI/networking demand expansion are expected to significantly boost Broadcom's revenue and improve net margins through various initiatives.
  
• Strategic focus on subscription models, cost reduction, and leading-edge technology development aims to enhance revenue predictability and secure Broadcom's technological leadership.
  
• Reliance on few hyperscale customers, risks in VMware subscription model transition, ongoing acquisition costs, NVIDIA competition, and software expansion challenges could impact revenue and margins.

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.

• Integration of VMware is significantly boosting Broadcom's infrastructure software segment revenue, which is expected to positively impact overall revenue growth.
  
• Transition of VMware products to a subscription licensing model is enhancing revenue predictability and could increase customer stickiness, potentially leading to sustained revenue streams.
  
• Expansion in AI and networking due to strong demand from hyperscalers is expected to drive robust growth in semiconductor revenue, contributing to increased overall revenue and improved net margins.
  
• Cost reduction initiatives post-VMware acquisition, including streamlining operations and reducing the spending run rate, are likely to enhance operating margins.
  
• Efforts in leading the transition to 800-gigabit optical interconnects in AI data centers and development of next-generation switches and optics are set to secure Broadcom's technological leadership, fostering long-term revenue growth from cutting-edge technology sectors.

Assumptions

• Analysts are assuming Broadcom's revenue will grow by 19.6% annually over the next 3 years.
• Analysts assume that profit margins will increase from 24.0% today to 38.9% in 3 years time.
• Analysts expect earnings to reach $28.4 billion (and earnings per share of $6.27) by about July 2027, up from $10.2 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $27.9 billion in earnings, and the most bearish expecting $14.2 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 58.1x on those 2027 earnings, down from 77.1x 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 grow by 12.79% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 8.74%, as per the Simply Wall St company report.

Risks

• Heavy reliance on a few hyperscale customers for the custom AI accelerators business could lead to revenue volatility if these customers adjust their purchasing patterns or start developing in-house solutions, impacting overall revenue.
  
• The transition of VMware products to a subscription licensing model, while potentially increasing long-term stability, carries execution risk and may impact short-term revenue as customers adjust to the new billing model.
  
• Ongoing integration and restructuring costs related to the VMware acquisition, if higher than anticipated, could erode net margins in the short to medium term.
  
• Competition from NVIDIA in both accelerators and Ethernet switching could pressure Broadcom's market share and margins in these areas, potentially impacting revenue and profitability in the semiconductor segment.
  
• Broadcom's software business expansion and customer traction, despite progress, face risks from market competition and customer adoption rates, which could impact future growth and margins in the infrastructure software segment.

Valuation

• The analysts have a consensus price target of $192.07 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 $150.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $72.9 billion, earnings will come to $28.4 billion, and it would be trading on a PE ratio of 58.1x, assuming you use a discount rate of 8.7%.
  
• Given the current share price of $169.38, the analyst's price target of $192.07 is 11.8% 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.