Wait Before You Buy This Apple Supplier

Solid product developments in key areas are tailwinds for this company, but an expensive valuation is a worry.

Apr 11, 2014 at 3:00PM

One year ago, things were going quite well for Broadcom (NASDAQ:BRCM). The chipmaker was riding solid growth in smartphone sales, driven by Apple (NASDAQ:AAPL), Samsung, and others, while it was also trying to tap the cellular baseband market. Broadcom was also pioneering 5G Wi-Fi technology and preparing itself to benefit from growth in connectivity across the globe.

However, Broadcom stumbled, and stumbled massively. Smartphone sales started slowing, and the company's foray into the baseband market didn't yield much results. As a result, Broadcom is finding it difficult to deliver revenue and earnings growth now. In addition, the stock is pretty expensive at 42 times earnings. This is why even a dividend yield of 1.60% doesn't look attractive as there are cheaper and better dividend-paying stocks in the market.

But there have been some really strong developments made on the product side by Broadcom. The company is targeting key growth segments such as the Internet of Things, wearable devices, software-defined networking (SDN), and of course, the low-end (but high-volume) smartphone market.

The SDN opportunity
In each of these areas, Broadcom has released some impressive products of late. To address the needs of the rapidly growing software-defined networks, Broadcom recently announced a reference platform for OpenFlow – a method of implementing software-defined networking. Broadcom claims that its new OpenFlow Data Plane Abstraction v1.0 specification, software and API is one of its kind in the industry so far. This specification can be used to implement network virtualization, multi-tenant networks and traffic engineering on a higher scale and performance level.

The need for software-defined networking is growing by the day since it provides flexibility that isn't seen in a hardware-based network. This market is expected to multiply at a stupendous rate of more than 60% per year till 2018, driven by an increase in implementation of the architecture and growth in cloud computing. At present, the major headwind that SDN faces is that of implementation of the architecture, so Broadcom is targeting the right area by trying to address this problem with its product development moves.

Targeting wearables
Broadcom's industry-first efforts aren't just limited to SDN. Recently, Broadcom launched BCM4771 -- a Global Navigation Satellite System (GNSS) system-on-chip (SoC). According to Broadcom, this is the world's first navigation chip built on a specific design to be used in wearable devices such as smart watches and fitness trackers. In fact, Broadcom is already working with Google (NASDAQ:GOOG) on the Android Wear platform. 

Google is focusing on wearable devices such as smartwatches with Android Wear, and plans to extend this tech to more applications going forward. The search and technology giant has already started working with various chipmakers and electronic manufacturers on this platform, including Broadcom, as stated in a Google blog post. Moreover, Google has tied up with watch company Fossil to sell Android Wear watches later this year, suggesting that Mountain View is quite serious about this venture.

This is good news for Broadcom, and given that the global smartwatch market is expected to touch $9.2 billion in revenue by 2018, according to Business Insider. In addition, since Broadcom has a deep relationship with Apple, it could profit from the Cupertino-based giant's foray into smartwatches as well.

Smartphone's are still a big opportunity
At present, Broadcom is struggling with its Apple account. Broadcom saw weakness at Apple as the smartphone maker didn't use its latest 5G Wi-Fi standard in the iPhone 5s and the iPhone 5c. Apple stuck to the 802.11n Wi-Fi standard in the latest iPhones, and this hurt Broadcom's dollar content. In addition, the latest iPads didn't make the jump to the 5G Wi-Fi standard either.

However, Broadcom is positive about its 5G progress is of the opinion that its customers will transition to 5G Wi-Fi going forward. Broadcom is making a stronger case for the adoption of this technology with its BCM4354 system-on-chip that's expected to deliver twice the real-world speed. So, it might not be long before its key customers such as Apple adopt this technology.

Broadcom is also looking to make a dent in the entry-level smartphone market with its M320 and M340 LTE system-on-chip designs. Broadcom expects these new chips to power sub-$300 LTE smartphones; hence it is primarily targeting the rapid growth that's expected in China. According to iSuppli, 4G handset shipments in China are expected to hit 72.6 million this year from just 4.6 million last year. By 2017, these shipments are expected to touch 300 million units, so this is yet another area where Broadcom is making the right move.

Final words
Broadcom is moving on many fronts. If the company is able to execute on these moves properly, then it could be a strong buy going forward. However, investors should exercise caution as Broadcom is expensive, and its earnings are declining. But the stock could be a good buy on the pullback as Broadcom's long-term prospects look strong.

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Harsh Chauhan has no position in any stocks mentioned. The Motley Fool recommends Apple and Google (C shares). The Motley Fool owns shares of Apple and Google (C shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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