On its recent earnings call, tech giant Broadcom (NASDAQ: AVGO) disclosed it would be splitting its stock 10-for-1 on July 12. Given that Broadcom’s stock surged over 12% to $1,700 per share the day after its report, one could perhaps say a stock split was overdue.
Of note, Broadcom’s stock split won’t change the value of the company itself, which currently sits around $780 billion. While stock splits can perhaps make it easier for retail investors and employees to buy shares (such as in employee stock purchase plans), splits don’t change the fundamentals of a company, such as its earnings, revenue growth, or intrinsic value.
As such, a stock split is never a reason to buy a stock. However, Broadcom also offered compelling reasons for its post-earnings pop and continued ownership, especially in its two most important product segments.
VMware is looking like a home run
While Broadcom has historically been primarily a semiconductor company, its software segment now makes up over 40% of revenue, coming in at 42% of last quarter’s top line. That’s thanks to the $69 billion acquisition of VMware, which closed in the fourth quarter of last year.
VMware is already looking like a home run for Broadcom. Not only has Broadcom been able to wring out a significant amount of cost from VMware — somewhat typical when a large company acquires another — but it has also been able to reaccelerate VMware’s revenue growth.
In its fiscal second quarter of 2024, VMware revenue came in at $2.7 billion, up from just $2.1 billion in the prior quarter. That’s an incredible 29% acceleration in just one quarter, annualizing to a stunning 173% growth rate!
Broadcom has been able to accelerate VMware’s transition to a recurring subscription model as opposed to one-off license purchases, a transition that was already under way pre-acquisition. But perhaps more important is the recent introduction of vSphere, a new platform that allows companies to virtualize all parts of their on-premises data centers, enabling employees to use a company’s data center as easily and intuitively as public clouds. This is opposed to prior offerings that only virtualized one aspect of a company’s data centers, such as compute, networking, or orchestration.
Whether or not this has been due to Broadcom’s influence or VMware’s R&D efforts leading up to the acquisition, Broadcom is now reaping the benefits.
On the conference call with analysts, Broadcom CEO Hock Tan said he sees VMware’s revenue reaching $4 billion on a quarterly basis in short order. Not only that, but Tan sees Broadcom eventually being able to cut out a massive amount of overhead costs, trimming VMware’s quarterly operating expenses from $2.3 billion pre-acquisition to $1.6 billion last quarter, on the way to eventually reaching $1.2 billion.
In VMware’s last stand-alone quarter ended in July 2023, it garnered an 81.2% gross margin. So assuming the segment gets to Tan’s $16 billion in revenue, and Broadcom can maintain VMware’s historical gross margins while cutting quarterly operating expenses to $1.2 billion, VMware’s operating profit should theoretically improve to $8.2 billion — an incredible profit figure on a $69 billion purchase, after just a year or two, especially for a “sticky” enterprise software platform that tends to get a high multiple in the public markets.
And Broadcom’s AI products are firing on all cylinders
In addition to VMware, Broadcom’s AI product portfolio continues to shine. As a reminder, Broadcom has two broad categories of AI products: networking products, such as ethernet-based switching chips and digital signal processors, and custom ASIC (application-specific integrated chip) IP, which cloud companies are using to build their own custom AI accelerators. For custom ASICs, Broadcom counts Alphabet and Meta Platforms as customers, with a third that is rumored to be Tik Tok parent Bytedance.
Broadcom’s total “networking” category, which incorporates these two product lines, surged 44% last quarter to now make up just over half of the company’s semiconductor revenue, at 53%.
Tan highlighted especially strong growth in switching chips, PCIe switches, and networking controllers, which all doubled over the prior year, as networking and memory have actually become the main bottlenecks to AI computing.
Moreover, the strong results may have assuaged concerns that Nvidia‘s (NASDAQ: NVDA) Infiniband technology may be taking share from ethernet, where Broadcom dominates. In fact, Tan noted that seven of the eight largest AI clusters last year ran on ethernet technology, and that all eight in the coming year will operate on ethernet technology. And while Nvidia is also coming out with its own new ethernet products, Broadcom is the established leader and is obviously currently seeing very strong momentum.
Broadcom continues to be a core tech holding
Broadcom isn’t as cheap as it was before AI took hold, at about 40 times last quarter’s annualized run-rate earnings. However, AI growth continues to be extremely strong, while the company hasn’t even seen all of the financial benefits of its VMware integration kicking in yet.
Meanwhile, outside of AI and software, Broadcom’s other segments have shown low or even negative growth, with mobile chips at just 2% growth last quarter, storage connectivity hardware down 27%, and broadband revenue down a whopping 39%. However, Tan said the company sees these non-AI segments bottoming and then beginning to recover in the back half of the year.
So with VMware profits inflecting up, AI revenue exploding, and non-AI revenue recovering from a downturn, look for Broadcom’s profits to surge through the back half of the year and beyond, likely making the stock much cheaper on a forward earnings basis.
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Broadcom’s Stock Split Isn’t a Reason to Buy Shares: These 2 Reasons Are was originally published by The Motley Fool
Source: finance.yahoo.com