After Nvidia's (NVDA -0.79%) massive 2023 run, investors are now looking for the next big AI stock to enjoy similar growth and profitability.
Broadcom (AVGO -2.60%), which is actually the second-largest semiconductor company in the U.S. and fourth-largest globally by market cap, soon found favor with investors as another lower-priced AI play this year.
As its name implies, Broadcom has a diversified and highly profitable portfolio across several technology end markets. Yet about 15% of its revenue is directly involved in booming generative AI applications. These include its market-leading switching and routing chips needed to direct data around and between data centers, along with custom ASIC compute offload engines that are now being incorporated into non-Nvidia AI accelerators like Alphabet's tensor processing units.
Broadcom's stock took off in May on that thesis, though not quite to the same extent as Nvidia, and is up 55% on the year. But the stock pulled back quite a bit after it reported third-quarter earnings on Sept. 1.
However, one of Broadcom's directors seems to think the post-earnings dip is an opportunity, buying up a significant amount of stock last week.
A director ups his stake
On Sept. 6, Broadcom director Check Kian Low purchased nearly $9.6 million of Broadcom shares on the open market at a price of just over $872 per share. But perhaps just as important as the dollar amount, the stake amounted to a 122% increase in Low's existing position prior to last week. Even more interesting, despite Low having been a Broadcom director since 2016, this was his first open-market purchase, with his initial stake coming from restricted shares earned as compensation for his service on the board. Finally, another point of interest is that Low is actually a professional investor, as a founder of investment management firm NewSmith Capital Partners.
One wonders why, after being on the board for so long, Low chose now to buy so much stock near all-time highs.
Likely, the answer is generative AI, which burst onto the scene this year, and how Broadcom will benefit from it. Right now, there appears to be a solid base of growth, and two big catalysts that could lead to significant upside.
The base AI ethernet networking business is booming
Broadcom's management believes that although the AI business is only about 15% of semiconductor revenue today, it will grow by leaps and bounds over the coming years. On the recent third-quarter conference call with analysts, CEO Hock Tan said the company's generative AI-related products grew a whopping 50% sequentially and nearly 100% year over year and that trends are accelerating. That should enable the generative AI portion of the business to exceed 25% of semiconductor revenue next year, supporting solid growth for Broadcom's overall business.
Broadcom released its newest switching chip, the Tomahawk 5, back in August 2022, ramping to production volume in March 2023. The company released its Jericho 3-AI chip for AI fabrics that same month of March 2023, just as the AI revolution was skyrocketing.These ethernet-based switching and routing platforms, which offer multiples of the prior generation's bandwidth and a fraction of the power consumption, are now in super-high demand as cloud hyperscalers update their routing and switching platforms to handle the extreme traffic of AI workloads.
And the breakthroughs should continue. Broadcom and other industry heavyweights formed the Ultra Ethernet Consortium (UEC) in July with the goal of innovating on ethernet architecture for generative AI while also promoting interoperability. CEO Hock Tan is optimistic that even more compelling innovation is coming, saying:
We are obviously excited that generative AI is pushing our engineers to develop cutting-edge technology in silicon technology that has never been developed before. We know the end of Moore's Law has set limits on computing in silicon technology, but what we are developing today feels very much like a revival.
Broadcom is investing behind its high-growth AI portfolio. Image source: Getty Images.
A new integrated photonics platform could disrupt the industry
The growth of the Tomahawk and Jericho platforms is likely appreciated by investors, but Broadcom has another trick up its sleeve that could lead to significant upside.
In addition to these switching chips, Broadcom plans to integrate them with silicon photonics in a single silicon package. The result is an integrated chip that greatly lowers the power required for the switching system. In addition, Tan believes the silicon-based system will have greater production yields than current optical components, further lowering costs.
Typically, optical transceivers are produced separately from the switching chip, but Broadcom has aggressively invested in this integrated optical push. With a proof of concept now complete, Broadcom will be introducing these integrated chips next year.
This is something that hasn't been done before and could be a big deal that may disrupt other current optical transceiver and components companies if it works:
... we will get it in one or two hyperscalers who will demonstrate how efficient power-wise and effective it can be. And once we do that, we hope it will start to proliferate to other hyperscalers because they cannot do it if one of them does it and reap the benefits of this silicon photonics solution ... the power is simply enormous, 30%, 40% power reduction. And power is a big thing now in data centers, particularly, I would add, in generative AI data centers... That's a big use case that could come over the next couple of years.
So, while Broadcom's AI opportunity is somewhat appreciated, the disruption of the related silicon photonics market could be what Low sees in his buy.
And don't forget VMWare
Finally, Broadcom is hoping to close its acquisition of software company VMWare (VMW) by Oct. 30; it only needs final approval from China to go through. Nothing is set in stone, but the deal spread did narrow on Sept. 6 amid reports that the company had had positive discussions on remedies to satisfy Chinese industry and government officials. Interestingly, that was the same day Low bought shares on the market.
The massive $61 billion acquisition would transform Broadcom into a company split 50-50 between chips and software. Importantly, VMware's platform allows companies to manage their computing workloads across multiple public and private clouds, as well as on-premises. As more and more companies will need to switch between platforms quickly and securely in the age of AI, VMware is very well positioned.
So between AI growth, the new integrated optical packages, and VMware, it's perhaps not surprising that an insider decided to up his bet on Broadcom's shares last week as the stock pulled back.
