Broadcom Reports Slowing Growth as It Awaits Final VMware Acquisition Approval -- Time to Buy the Stock?

On the surface, chip giant Broadcom (AVGO 3.84%) seems to have just turned in a lackluster quarterly performance as a new era of artificial intelligence (AI) supercharges prospects for some semiconductor companies. CEO Hock Tan and company reported decelerating revenue growth in the fiscal third quarter of 2023 (the three months ended in July) compared to earlier this year. 

However, Broadcom is in fact outperforming most of its peers right now, and its pending merger with cloud computing infrastructure company VMware (VMW) could set the stage for another run higher. Is Broadcom stock a buy right now? 

AI provides a small boost

Excluding Nvidia's massive GPU boom and companies that supply the automotive (and specifically electric vehicle) space, most of the semiconductor industry is in a deep slump. It started late last year with an oversupply of chips for PCs and smartphones, and since then has expanded to cloud computing chips -- especially non-AI cloud (again, an effect exacerbated by Nvidia). 

This latter downturn is exemplified by leading network connectivity chip designer Marvell Technology, a key competitor of Broadcom. Marvell just reported a 12% year-over-year decline in sales, and a resulting slump in profit margin.  

But not Broadcom. It just reported a 5% year-over-year increase in revenue to $8.88 billion, and earnings per share (EPS) and free cash flow (FCF) increased 8% and 7%, respectively, compared to last year. Incredibly, FCF profit margins were up once again and dialed in at nearly 52% during the quarter.  

It is worth noting that Broadcom's 5% revenue advance in fiscal Q3 does represent a sharp slowdown from 8% growth in the second quarter and 16% growth in the first quarter. However, growth is growth, and that's especially notable whenever peers are in decline. Basically, giant Broadcom continues to scoop up market share of the semiconductor universe.

Data source: Broadcom. YOY = year over year.

The standout segment last quarter was networking, which is where Broadcom reports revenue from its AI networking chips, the Tomahawk 5 switching chip (which connects clusters of GPUs together) and the Jericho3-AI router (which helps coordinate the flow of traffic within a data center). Excluding AI networking, Broadcom's semiconductor business was flat year over year. Nevertheless, the company has orchestrated a "soft landing," and is targeting more gradual growth for the remainder of 2023 and into the beginning of 2024.

What about the VMware acquisition?

Broadcom has received regulatory approval to take over VMware in all jurisdictions except China. Tan and the top team continue to be confident approval will be granted, and the two businesses will combine by October 30, the end of Broadcom's 2023 fiscal year.

This will be transformational, splitting Broadcom's focus between chip design and software development. It's getting VMware for a decent deal, too. VMware sales over the last 12 months were $13.6 billion, up just 3.6%. But free cash flow rose 47% to $4.66 billion, an FCF profit margin of 34%. Broadcom hopes to boost this cash generation even further by folding VMware into its existing infrastructure software business, which was also built by acquisitions over the past decade.  

VMware is now valued at a market cap of nearly $71 billion as of this writing (the deal will be paid for in approximately half Broadcom stock, half cash). Based on this valuation, Broadcom is purchasing VMware for about 16 times free cash flow. Not bad, especially if Tan is able to apply his past acquisition playbook to VMware and further juice FCF profit margins to 50% and beyond.  

Time to buy Broadcom stock?

Broadcom stock was dirt cheap late in 2022 and into early 2023, and that value trade is now gone. Still, at 21 times trailing-12-month free cash flow, this is by no means a ludicrously expensive stock.  

Broadcom has been a great dividend growth story, and has supplemented shareholder returns with ample stock repurchases. The plan is much the same going forward once VMware is in the fold. Broadcom may not be the timeliest purchase right now, but for investors looking for top semiconductor and cloud computing stocks for the decade ahead, this is still a great buy-and-hold candidate in my book.