Broadcom Plus VMware Equals Strong Growth

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Broadcom Inc. (AVGO) is a top-five global fabless semiconductor company with leading franchises in wired and wireless communications, enterprise data center and storage, and other end markets, notes Jim Kelleher, an analyst with Argus Research.

The former Avago acquired Broadcom for $37 billion in 2021 and changed its name to Broadcom Inc. Late in May 2022, Broadcom announced a definitive agreement to acquire VMware (VMW) for $61 billion in a half-cash and half-stock deal, along with $8 billion in net debt assumption.

Broadcom believes acquiring VMware advances the company’s strategy to build the world’s leading infrastructure technology company. Following the deal's close, which is set to occur during the company’s fiscal 2023 year, Broadcom Software Group will rebrand and operate as VMware.

Broadcom, with its size and its acquisition track record, is one of a very few companies in the technology space qualified to pull off this deal. Given the overlapping focus in enterprise and AI data center of the two companies, along with complementary rather than redundant assets, we believe Broadcom has made the proper strategic decision on its path to becoming the world’s leading infrastructure technology company.

Broadcom continues to demonstrate its ability to execute as an integrated data center solutions provider in a challenging supply chain environment. The absorption and seamless integration of past software assets, namely CA Inc. and the enterprise security business of Symantec, sends a positive message regarding Broadcom’s ability to acquire, integrate, and optimize the VMware business.

AVGO trades at 13.3-times our FY22 non-GAAP estimate and at 11.9-times our FY23 forecast, or at an average two-year-forward P/E of 12.6-times. The forward P/E is below the historical five-year (FY17-FY21) trailing P/E of 13.3, even though Broadcom is now growing much faster and is higher-margined than in the past.

AVGO trades at a relative P/E of 0.74 on a two-year-forward basis, above its historical five-year trailing relative P/E of 0.72 but at a discount to the market. Fair value based on comparable historical multiples is in the upper-$400's to low $500's and in a rising trend, in line with current prices.

Peer group analysis shows AVGO trading well below peers on forward P/E, price/sales, and EV/EBITDA. In the tech selloff, peer indicated value has come down to the mid-$600's, though it remains well above current levels.

Discounted free cash flow analysis points to a value of $1,100, which is in a stable trend and above current levels. Cash flow generation should accelerate further as the company integrates high-margin assets and achieves volume leverage and greater synergies across its operations.

Our blended valuation analysis indicates a fair value for AVGO in the $860 range, above current levels and in a stable to rising trend. Calculated fair value remains well above the current stock price.

Appreciation to our 12-month target of $715 implies a potential risk-adjusted total return, including the 3.3% dividend yield, in excess of our forecast for the broad market. On that basis, we are reiterating our buy rating.

About the Author

James Kelleher has worked in the financial services industry for over 25 years and joined Argus in 1993. Mr. Kelleher is the director of research at Argus and a member of the Investment Policy Committee. He has been instrumental in building Argus' proprietary valuation models, which are a key part of the proprietary Argus Six-Point Rating System.

Mr. Kelleher also oversees Argus' technical analysis products, writes the Portfolio Selector report and other publications, and manages several Argus model portfolios. As a senior analyst, he covers communications equipment, semiconductors, information processing, and electronic manufacturing services companies.

Mr. Kelleher is a CFA charterholder, and is a three-time winner in The Wall Street Journal's Best on the Street All-Star Analyst Survey. In July 2010, McGraw-Hill Professional published his book, Equity Valuation for Analysts & Investors. The book, a single-volume treatment of financial modeling and valuation process, introduces the Argus proprietary valuation methodology known as Peer Derived Value.

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