As the meteoric rise of mobile devices continues, an interesting way to play the multi-year secular growth story of these revolutionary devices has been to invest in semiconductor component suppliers with a good amount of exposure to these hot gadgets. Broadcom (NASDAQ: BRCM) is a chipmaker that, has enjoyed tremendous success during this mobile "boom" with its connectivity combo chips (which combine Wi-Fi, GPS, Bluetooth, and NFC into one chip).
Unfortunately, the most recent quarter wasn't exactly what shareholders were looking for. Thanks to a weaker-than-expected performance in mobile and wireless (driven largely by 3G baseband weakness), coupled with fears that the company's 4G LTE baseband efforts would be later-than-expected (material revenue had been pushed into the second half of 2014) as well as fears of potential connectivity combo chip share loss, Broadcom's shares saw a haircut of over 33% of their value nearly overnight.
However, on September 4, Broadcom announced that it had acquired the cellular assets of Renesas Electronics, and I believe that it's time for investors to take notice as this could really be a game changer for the company.
What's the scoop?
There's no doubt that cellular baseband and RF are very difficult, and Qualcomm's long heritage as a cellular and wireless company has allowed it to essentially monopolize the LTE handset market over the last couple of years. Broadcom, Intel, and NVIDIA have been very rapidly pushing their own LTE efforts in a bid to finally offer an alternative to Qualcomm's offerings, albeit roadblocks and delays have been the name of the game for each of them.
Earlier this year, Broadcom began showing off its own discrete LTE modem and had promised that it would begin shipping for revenue at some point during 2014. Of course, investors got a little ahead of themselves and believed that revenues from this effort would be an early 2014 event and thus were disappointed when management noted that this would actually be a second half of 2014 event.
However, the acquisition of Renesas Electronics' struggling mobile division (that had been in the process of winding down), seems to really change the game for Broadcom. Right off the bat, the company gets a fully integrated system-on-chip with an LTE-Advanced cellular baseband that's validated with multiple carriers including AT&T and NTTDoCoMo. Management expects to be able to deploy this very quickly with material revenue coming in the early part of 2014.
While the deal hurts EPS in the short term, it should become accretive to EPS by 2015. Moreover, a major overhang on Broadcom's share price – the viability of its cellular efforts – should finally be lifted, leading to a near-term improvement in sentiment, and more importantly a new long term revenue stream.
Going for a larger slice of the pie – Bigger risk, even bigger reward
Broadcom's bread-and-butter in the wireless space – connectivity – is a good business that has grown nicely over the last couple of years. However, the problem is that its connectivity combo chips go for $3-$6, while selling the entire cellular platform (apps processor, connectivity, and cellular) can gross a company somewhere in the range of $10 to $30 per chip. Even better is that this opportunity is largely incremental, as the company already provides connectivity to many platforms that do not use its apps processors or cellular baseband and RF.
However, the risks are also clear. Developing cellular and RF technology is expensive, and building entire system-on-chip platforms is even more so. At some point, these significant investments in cellular need to pay off, particularly as shareholders become increasingly impatient. It's not exactly confidence inspiring that Broadcom is essentially throwing its own LTE modem out and instead is replacing (while salvaging anything that could be used) it with a modem bought for a mere $164 million in overseas cash.
However, I do remain optimistic that Broadcom's efforts will indeed pay off. This is a company that is very engineering-centric (77% of its employees are engineers), and the company's connectivity business – as well as its networking infrastructure and home divisions – are more than profitable enough to support what needs to be done here.
The question is now all about timing and execution. If management can deliver on LTE revenues during early 2014 and if it can follow that up with a next generation, quad-core integrated part during the third quarter of 2014 as promised, then the company's efforts – as well as the stock – should be in good shape going forward. If not, investors are going to start asking some tough questions about the longer-term viability of this business.
The Foolish bottom line
While I'm disappointed that Broadcom's own internal efforts ran into a snag, I'm happy that the company got its hands on a rather choice piece of LTE hardware and a great team to go with it. I'm optimistic that investor sentiment toward Broadcom's longer term growth prospects will finally turn, and if I'm right, it will be a nice few years of renewed growth in mobile & wireless for the company as it takes more of the handset dollar content than it currently has.
