Image Source: Broadcom Inc – June 2020 IR Presentation

By Callum Turcan

On June 4, Broadcom Inc (AVGO) posted second quarter earnings for fiscal 2020 (period ended May 3, 2020). Shares of AVGO are trading in the upper bound of our fair value estimate range and appear reasonably priced as of this writing considering the relatively favorable forward-guidance management offered for the fiscal third quarter. Though the ongoing coronavirus (‘COVID-19’) pandemic is negatively impacting Broadcom’s operations with an eye towards “challenges” at the firm’s supply chain, the company’s growing ‘Infrastructure software’ segment appears to be helping stabilize its financial performance.

We give Broadcom a Dividend Cushion ratio of 1.0, earning the firm a “GOOD” Dividend Safety rating (these metrics factor in expectations that the firm will push through meaningful per share dividend growth over the coming fiscal years). While Broadcom carries a hefty net debt load, its business model is light on capital expenditures which allows for the firm to generate meaningful free cash flows. Shares of AVGO yield ~4.2% as of this writing.

Financial Overview

At the end of the fiscal second quarter, Broadcom had $9.2 billion in cash and cash equivalents on the books which was stacked up against $0.8 billion in short-term debt and $45.0 billion in long-term debt. Broadcom’s large total debt load is a product of its acquisitive streak as the company could be described as a serial acquirer. We view Broadcom’s net debt position as manageable given its strong cash flow profile and investment grade credit ratings.

Broadcom generated $5.3 billion in free cash flow during the first half of fiscal 2020 while spending $2.8 billion covering its dividend obligations during this period. Additionally, the firm did not spend a significant amount repurchasing its common stock in the first half of this fiscal year. 

Fitch gives Broadcom the lowest investment grade credit rating (BBB-) though that comes with a negative outlook as of April 2020. Moody’s Corporation (MCO) reaffirmed Broadcom’s investment grade credit rating (Baa3) in June 2020 with a stable outlook, though that is also the lowest investment grade credit rating at the agency. Considering the Fed has aggressively intervened in US corporate debt markets as part of its strategy to stabilize the economy during the pandemic, Broadcom likely continues to have access to debt markets at attractive rates.

Please note Broadcom recently completed some major refinancing activity, which according to management modestly increased the company’s cost of debt though its maturities were pushed back significantly (from Broadcom’s latest quarterly conference call):

“On the financing and investing front, we derisked our balance sheet with over $18 billion of debt refinancing, including $2 billion of commercial paper. This allowed us to push out average debt maturities to six years from four years, while our average cost of debt increased by just above 50 basis points.

Note these figures are inclusive of the $8 billion financing and $3. billion – $3.9 billion, excuse me, exchange offering that we executed in the first month of our third fiscal quarter.

All told, we ended the quarter with $9.2 billion of cash and currently have $14.2 billion of liquidity, including our $5 billion revolver. Note, we did drawdown $3 billion on our revolver earlier in the quarter, all of which we have repaid as part of our refinancing activity. We ended the quarter with $45.8 billion of total debt, of which approximately $800 million is short-term.” --- Thomas Krause, CFO of Broadcom

Broadcom’s $5.0 billion revolving credit line matures in May 2024, and as management noted up above, the firm repaid the $3.0 billion of the credit facility’s borrowings that were outstanding as of the end of its fiscal second quarter during the fiscal third quarter. That was made possible through various refinancing activities completed by Broadcom in the fiscal second and fiscal third quarters. As things stand today, Broadcom appears to have ample liquidity to ride out the storm created by COVID-19. Management remains “committed” to the firm’s current dividend policy as Broadcom “navigate[s] this uncertain environment.”

Operational Overview

Back in November 2019, Broadcom completed its all-cash acquisition of then-Symantec’s enterprise security business for $10.7 billion. Symantec rebranded itself as NortonLifeLock Inc [NLOK] after the deal closed. A year earlier, Broadcom completed its all-cash acquisition of CA Technologies through a deal worth ~$18.4 billion by enterprise value in November 2018. These deals were made to bulk up Broadcom’s Infrastructure software revenues, which were up 21% year-over-year in the fiscal second quarter.

On a sequential basis, Broadcom’s Infrastructure software segment’s revenues grew by 3% in the fiscal second quarter, reaching over $1.7 billion, while its ‘Semiconductor solutions’ segment’s revenues dropped by 4%, hitting $4.0 billion. Please note that as the first quarter of fiscal 2020 (period ended February 2, 2020) started November 4, 2019, the same day the Symantec deal closed, the aforementioned sequential revenue growth in Broadcom’s Infrastructure software segment’s revenues appear to be largely organic.

During Broadcom’s latest quarterly conference call management mentioned that the company had “successfully integrated Symantec onto the Broadcom platform” and that the firm was close to completing its transition efforts. Revenues at the new unit were up 2% sequential according to management and bookings growth at Broadcom’s “core accounts” seemed to be holding up well, relatively speaking. Pivoting to the operations Broadcom acquired by buying CA Technologies, revenues from that division were up 2% sequentially and management also noted that “bookings in our core accounts grew double digits annually” at this division.  

Guidance

While management guided for Broadcom’s Infrastructure software segment’s revenues to decline by 7% sequentially in the fiscal third quarter, please note that is entirely due to expected softness at its Brocade division which primarily offers products and services for data centers. Broadcom acquired Brocade through an all-cash ~$5.9 billion deal that closed in November 2017. Management noted that (from Broadcom’s latest quarterly conference call):

“Looking ahead to next quarter [fiscal third quarter], we expect revenues from CA and Symantec, of course, to sustain on a sequential basis. However, very consistent with our distribution strategy in semiconductors, we are reducing channel inventory significantly for Brocade and expect Brocade revenue will be down significantly quarter-on-quarter in Q3.

So as a result, we expect revenue from the Software segment to be down approximately 7% sequentially in the third quarter. So, in sum, we expect our consolidated third quarter net revenue to be $5.75 billion, roughly flat from Q2. This reflects a 3% sequential projected revenue increase in semiconductors and a 7% sequential expected revenue decline in software.” --- Hock Tan, CEO of Broadcom

Pivoting to Broadcom’s Semiconductor solutions segment, the forecasted rebound in the segment’s sales on a sequential basis is a promising sign. This segment caters to networking, broadband, industrial, wireless, and enterprise storage needs in the realm of IT and telecommunications. Management noted that demand for networking-related offerings rebounded sharply in the fiscal second quarter and were up 11% on a sequential basis. Broadcom cited the ramp up in sales of its “next-generation Tomahawk 3 and Trident 3 switch products at our various cloud customer, and in network routing, Jericho 2 at our telco customers” as playing a key role in that recovery.  

Going forward, management noted that this “steady recovery (regarding its networking offerings) which we saw in Q2 is now turning into a demand surge in Q3 as we are seeing strength for existing generation products in addition to this next-generation range.” Some of Broadcom’s other offerings in this category were starting to see a pickup in demand as well.

At Broadcom’s wireless division within the Semiconductor solutions segment, the firm is guiding for its revenues to fall sequentially this fiscal quarter after declining sequentially in the second fiscal quarter as “the ramp of next-generation phone at our large North American mobile phone customer” likely will not occur until Broadcom’s fiscal fourth quarter. Apple Inc (AAPL) represented ~20% of Broadcom’s net revenues in fiscal 2019 and ~25% of Broadcom’s net revenues in fiscal 2018, which is likely the company Broadcom’s management is referring to here.

For reference, there is a good chance Apple is getting ready to launch a 5G-capable iPhone later on this calendar year according to some tech publications, though nothing is for certain. Back in January 2020, Broadcom published a current report that noted the firm had just made two new deals with Apple to supply it with wireless components over the next several years, which built upon a deal reached in mid-2019. Combined, these agreements are expected to generate ~$15.0 billion in future revenues for Broadcom over the coming years, according to the current report.

Broadcom generated ~$5.75 billion in GAAP revenues in the fiscal second quarter and management guided for the firm to generate $5.75 billion (plus/minus $150 million) in revenues in the fiscal third quarter (period ended August 2, 2020). On a non-GAAP basis, Broadcom generated $3.2 billion in adjusted EBITDA last fiscal quarter and management forecasts the firm will generate approximately $3.2 billion (plus/minus $75 million) in adjusted EBITDA this fiscal quarter. Effectively, Broadcom expects to match its fiscal second quarter financial performance during the fiscal third quarter.

On a year-over-year basis, Broadcom’s GAAP revenues declined marginally last fiscal quarter, though there is a lot of noise here due to headwinds created by the pandemic on one hand and the tailwind from acquisition activity on the other. We prefer to take a forward-looking approach when it comes to valuation analysis as the intrinsic value of an equity comes from market expectations of the company’s future discounted free cash flows, not historical data.

Concluding Thoughts

We caution that while Broadcom is a very free cash flow positive entity, its net debt load remains a significant though manageable concern. Management seems confident that Broadcom’s revenues, and likely its cash flows, will hold up during the pandemic in part due to the strength of the relatively new additions to its Infrastructure software segment and in part due to the pending launch of Apple’s next generation iPhone and the uplift that will have on Broadcom’s Semiconductor solutions segment. Broadcom would still be wise to build up its cash balance and pare down its net debt load during these harrowing times.

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Broad Line Semiconductor Industry – AMD AVGO FSLR INTC TXN

Communications Equipment Industry – CSCO JNPR KN NOK SMCI

Integrated Circuits Industry – ADI MCHP MRVL NVDA SWKS TSM XLNX

Semiconductor Equipment Industry – AMAT CREE IPGP KLAC LRCX MKSI SNPS TER

Related: AAPL, ASML, CAJ, MCO, NINOY, NLOK, SMICY, SSNLF, TRMC, TSM

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Callum Turcan does not own shares in any of the securities mentioned above. Apple Inc (AAPL), Cisco Systems Inc (CSCO) and Intel Corporation (INTC) are all included in both Valuentum’s simulated Best Ideas Newsletter and Dividend Growth Newsletter portfolios. Both the simulated Best Ideas Newsletter and Dividend Growth Newsletter portfolios include a SPDR S&P 500 ETF Trust (SPY) put option holding with a $295 per share strike price that expire on August 21, 2020. Some of the other companies written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.