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November 22, 2000

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Subject:  Valuing BRCM
Author:  GorillaGorilla

Valuation of BRCM has been a contentious issue (well, since its decline :-) ). To try and help my understanding of the situation, I've adapted a message orinally posted by me on the Cree board. So I apologize to anyone who has read the Cree version. Also, I use information from an original post by Herve. And most importantly TMFFuzz, who originally introduced the concept to the boards.

Anyway, Valuation is a tricky subject. There are two ways of valuing this company. The first is to look at the metrics the second is to look at it's potential.

Metrics - Growth Duration

Growth duration is a way of getting a feel for a stock to see if its price is in line with its growth. Growth rates are not sustainable forever; otherwise BRCM would be larger than the world economy (hurray)! Just how long would BRCM have to grow at its projected rates to justify its stock price? And is the growth rate reasonable and sustainable? Growth duration helps to shed some light on those issues. (Paraphrased from TMFFuz)

This is the logic of the growth duration formula:

If you invest \$100 in the S&P 500 today, you will see earnings of \$3.02 the 1st year (100/33.1, the P/E ratio). These earnings grow at 20% a year. On the 5th year, the expected earnings amount to \$7.52.

If instead you invest \$100 in BRCM Inc, your 1st year earnings will only be \$0.77 (100/130 - because the P/E ratio would be higher), but the growth rate of 60% yields 5th year earnings of \$8.07. In other words, you would have passed the S&P 500. In fact it would take 4 and 3/4 years to match the S&P 500. After that, you could be content growing at the same rate as the S&P 500 to justify today's valuation.

OK, so if we agree that this is the concept. The working is:

Growth Duration = Log (P/E Firm / P/E Market) / Log ( (1 + g Firm) / (1 + g Market) )

where P/E is the price/earnings ratio and g the growth rate in percentage.

Growth Duration = Log (130/33.1)/ Log (1.60/1.2) = 4.76 years

So, it would take 4.76 years to justify its stock price. Which is within my tolerance.

(log in base 10 and natural log (a.k.a. ln) both work)

For my own amusement - now at a price of \$80 which is a P/E of 80.. we would find

Growth Duration = Log (80/33.1)/ Log (1.60/1.2) = 3 years

So after three years growth BRCM would have a P/E lower than the S&P and could grow at the same rate as the S&P to justify it's value.

Potential

It is clear that BRCM are wrapping up the communications chip market. They won't be happy until you'll get all the functionality you need in one chip. Who else is going to match that? Additionally they are effective at penetrating new markets and gaining ground on encumbants. Add that to the fact that broadband hasn't really kicked in yet and BRCM 25% upside over the last Q and we can see a company in fair value.

Eric Jhonsa on the Silicon Investor > Gorilla's Board has made a number of worthwhile posts:

• This is the post he responds to.
• Eric's first post.
• A must read.

This gives a flavor of what Broadcom is about.

Valuation Conclusions

Although a high P/E I do not find it out of tilt with its growth rate. Although, BRCM could trade at \$80 a share it would be highly undervalued. Needless to say, a couple years at 100% earnings growth, would destroy what it needs to do to justify its value.

G^2
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Appendix:

BRCM's current P/E

I've included all my working out to make it easy for you to check up on my posting.

I am using a P/E which is the earnings for the year 2000. Note this includes one quarter which has yet to be announced, but they are happy with. If this comes to pass then we can say...

Shares Outstanding * Share Price
P = 264800000 * 130 = 34,424,000,000
- i.e. a market cap of \$34 billion
Earnings Estimated with 1Q to come \$265,000,000
P/E = 34,424,000,000 / 265,000,000 = 130.

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