Broadcom (AVGO -0.00%) has become one of the leading players in the artificial intelligence (AI) infrastructure hardware race by leveraging its strength as a custom chip partner. The company built its reputation supplying networking gear to data centers, but its real growth engine today is with application-specific integrated circuits, or ASICs. These are custom AI chips that large hyperscalers (companies that own massive data centers) are starting to turn to help reduce costs when training large language models (LLMs) or running inference.
Unlike graphics processing units (GPUs), these chips are preprogrammed for specific tasks before they are built. This can lead to better performance and efficiency for the tasks for which they were designed, but they lack to ability to be reprogrammed, and thus are a lot less flexible.
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The company's playbook is simple, but it's hard to replicate. Broadcom works side by side with a few select customers to create chips programmed for specific purposes, leveraging its deep library of intellectual property (IP) around interconnects and energy-efficient circuitry. It then uses its close ties with foundry leader Taiwan Semiconductor Manufacturing (TSM 1.50%) to help produce the chips.
Broadcom has been seeing huge momentum in this area. It helped Alphabet (GOOGL -0.16%) (GOOG -0.04%) develop its Tensor Processing Units (TPUs) years ago to help power its cloud computing business and has stayed a key partner as those chips have evolved. It has also scored design wins with Meta Platforms and ByteDance.
Combined, it thinks these three customers are a $60 billion to $90 billion opportunity in fiscal 2027, which is huge considering it's on track to generate around $63 billion in revenue this year. It also recently announced that a fourth customer, widely believed to be OpenAI, has placed a $10 billion order with it for next year.
Broadcom's biggest risk
While everything appears to be clicking now for Broadcom, the same model that has propelled the stock higher is also where the biggest risk lies. Broadcom's ASIC business depends on a small set of very large customers. Losing even one would leave a noticeable hole in both revenue and profits. That concentration is not just a financial issue, as it gives those customers leverage and time to build their own chip design expertise.
We have already seen this story playing out in other corners of the tech world. Apple, one of Broadcom's biggest wireless component buyers, recently replaced one of the company's Wi-Fi chips with its own in-house developed Wi-Fi chip. Meanwhile, Alphabet previously found a cheaper Wi-Fi chip partner in Synaptics. This shows how determined big tech companies can be to lower component costs.
There are signs a similar shift could be coming in AI chips. Reports suggest Alphabet is working more closely with MediaTek on parts of its next TPU generation and taking on more of the design work itself. Hyperscalers have enormous capital budgets but are always looking to stretch every dollar spent on computing power. If they believe they can achieve the same performance with a cheaper partner or by doing the work in-house, they will ditch Broadcom.
As these companies learn more from working with Broadcom, they also gain negotiating power. This can lead to lower gross margins over time, even if the relationships remain intact. Meanwhile, the long design cycles in ASICs mean Broadcom commits resources years ahead of production, so any change in a customer's roadmap can make that investment less valuable.
For now, Broadcom has a technical edge. Its proprietary IP around high-speed SerDes (Serializer/Deserializer), its expertise in low-power design, and its ability to integrate advanced packaging at the latest TSMC nodes still make it the go-to partner for hyperscalers that want a custom solution. That has bought the company time and kept competitors like MediaTek at bay for now.
Investors, though, should not assume that the edge is permanent. History shows that once a few large tech companies can figure out how to lower costs by cutting out or switching to a new partner, they tend to do so. The stock's recent run-up is tied almost entirely to its custom AI-chip opportunity, which makes this a risk worth watching closely.
Broadcom is positioned well for now, but its success has armed its biggest customers with the know-how to one day go it alone or with a cheaper partner like MediaTek or AIChip Technologies. That is the kind of risk that does not show up in next quarter's numbers but can reshape the story over a few years if even one major customer decides it no longer needs Broadcom's help.
