Valuing Broadcom: How High Can It Go?

Following Broadcom's (NASDAQ: BRCM  ) announcement that it would cease pursuing cellular baseband and, in the process, save about $700 million per year in GAAP operating expenses, the shares have soared. While it is clear that this is directionally a net positive, a question worth exploring is just how much the company is actually worth following this dramatic move and whether the shares -- currently trading at a hair under $38 a piece -- still represent a compelling investment opportunity.

Sizing Broadcom's businesses
The chart below breaks Broadcom's business down into its three major operating segments and gives revenue and operating profit data for each:

Business

Revenue (2013E) (in billions)

Operating Profit (2013E) (in billions)

Mobile & Wireless

$3.91

$0.365

Broadband Communications

$2.22

$0.538

Infrastructure and Networking

$2.08

$0.655

All Other (i.e. stock based comp, one-time charges, and amortization of acquired intangibles)

$0.086*-revenues principally consisted of royalties from Qualcomm (NASDAQ: QCOM  ) , but no longer recurring.

($0.648) – excludes one-time writedown associated with NetLogic acquisition

Total Broadcom

$8.21

$0.91

Source: Broadcom

Now, note that following the company's divestiture/sale of the cellular business, the company's Mobile & Wireless business should see the following broad financial impact:

  • $600 million of non-GAAP R&D wiped away from Mobile & Wireless
  • $100 million of stock based compensation to be eliminated (from "All Other")
  • $500-$800 million of the company's connectivity business at the low-end and midrange becomes "at risk" as Qualcomm and MediaTek aggressively push their connectivity solutions along with their cellular products
  • $200-$250 million in cellular baseband revenue during the first half of 2014 (roughly implying cellular at a $400-$500 million annual run rate) goes away when the business is wound down/sold (generating only "tens of millions" of gross margin – let's call it $30 million)
  • $50 million of the savings from mobile will be reinvested in infrastructure and broadband

Constructing a new model
Let's assume that the size of the low-end/midrange connectivity market sits at the midpoint of the range given by Broadcom's management ($650 million) and let's assume that Qualcomm/MediaTek are able to take about 30% of that share away ($195 million or so wiped out). Assuming that this is mid-teens operating margin (15%) business, we can construct a new, more accurate representation of the what the business would have looked like in 2013 if the cellular business had been gone and the connectivity business lost the related share:

Business

Revenue (2013E ex-cellular est.) (in billions)

Operating Profit (2013E ex-cellular est.) (in billions)

Mobile & Wireless

$3.27

$0.876

Broadband Communications

$2.22

$0.513

Infrastructure and Networking

$2.08

$0.630

All Other (i.e., stock based comp, one-time charges, and amortization of acquired intangibles)

$0

($0.548) – excludes one-time writedown associated with NetLogic acquisition

Total Broadcom

$7.57

$1.471

Source: Broadcom, Ashraf Eassa estimates

With operating income set to grow approximately 61% as a result of the cellular divestiture, it's no wonder that the share price was up about 20% last week. Interestingly enough, before the announcement of the cellular divestiture, Broadcom's shares traded at $31-$32, or about 18 times operating income. Now, the following is crude (particularly as some investors probably expected Broadcom to pull the plug on cellular), but applying a similar multiple to the new estimates yields a $26 billion market cap or roughly $50/share.

Foolish bottom line
After running these numbers, it's clear that Broadcom's financials improve pretty dramatically as a result of the cellular divestiture even if you assume sizable share loss in connectivity and a complete wipeout of preexisting cellular revenues. Further, given that Broadband is probably a business that grows mid-single digits long-term, infrastructure a potentially low-double digit grower, and connectivity potentially poised for growth after the low-end and midrange take whatever hit they're going to take, the business looks in pretty good shape and the stock could go much higher in the long term.

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