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S&P Capital IQ


11/28/16 10:00:11 AM



This week's Focus Stock of the Week is Broadcom Ltd. (AVGO: $177), which carries S&P Capital IQ's highest investment recommendation of 5-STARS, or Strong Buy. AVGO is a leading provider of a broad range of analog semiconductor devices that are used in end products such as smartphones, hard disk drives, computer servers, consumer appliances, data networking and telecommunications equipment, enterprise storage and servers, and factory automation and industrial equipment. We note that the company changed its named to Broadcom from Avago after completing a transformative acquisition of the legacy Broadcom company earlier this year.

Our Strong Buy recommendation reflects our views about valuation and attractive growth prospects over the next 12 months. We expect AVGO to benefit from a favorable wireless landscape and greater global 4G technology adoption, and we also see opportunities in wireline. The acquisition of Broadcom has doubled AVGO's revenue base, brought significant scale and expanded the company's addressable market

We expect AVGO to continue to be among the most aggressive acquirers amid the current wave of consolidation in the semiconductor industry, providing significant potential for inorganic growth. Earlier this month, on November 2nd, AVGO announced its intent to acquire Brocade for $12.75 per share in cash, or $5.5 billion equity plus $0.4 billion of net debt. AVGO plans to retain BRCD s Fiber Channel SAN Switching Business and divest the IP Networking business. We believe the acquisition is highly complementary to AVGO s existing enterprise storage offerings. The deal is expected to close in the second half of FY 17.

Over the next several years, we look for AVGO's addressable market to expand, as the transition to more advanced mobile devices increases the amount of semiconductor content is being embedded in each device, specifically on the radio frequency (RF) side. This is also creating an explosion in the amount of data traffic that is going through data centers. We also see substantial growth potential from secular trends within the home as consumers have more devices, appliances, security platforms and other things connected together. All of this will require greater broadband access and we believe AVGO's existing product offerings positions the company to take advantage of all these powerful trends.

We forecast sales to increase 23% in FY 17 (Oct.), following our outlook for a 92% rise for FY 16 and a 62% increase in FY 15, aided by acquisitions. We expect growth to be driven by wireline and wireless opportunities from the Broadcom acquisition, which we see comprising about 80% of sales. We envision stable growth within wireline, the largest segment, driven by switching/routing products and broadband strength. We see AVGO being aided notably by improving wireless trends, led by greater content per mobile device, and think the company is benefiting from robust demand for the iPhone 7. Within enterprise storage, we see challenging but stabilizing fundamentals for hard disk drive, server and storage connectivity product lines.

We see gross margins widening to 61% in FY 17 compared to our 60% margin projection for FY 16. We see higher profitability, on greater scale and cost efficiencies from prior acquisitions. Specifically, we expect AVGO to achieve annualized cost synergies of at least a $750 million within 18 months after the closing of the Broadcom deal. By FY 18, the completion of the pending Brocade acquisition is anticipated to contribute about $900 million to EBITDA. We believe AVGO's long-term model supports a gross margin of about 60% and operating margin of 45%.

We project operating EPS of $11.26 in FY 16 (Oct.) and $12.95 in FY 17. We note that AVGO is set to report full-year FY 16 results after the close on December 8.

Our 12-month target price of $195 is based on a P/E multiple of 15X our FY 17 operating EPS estimate of $12.95, near comparable semiconductor peers.

Risks to our recommendation and target price include slower-than-expected consumer demand for handheld devices that use the company's products, lower demand for hard disk drives, greater-than-projected pricing pressure, and competitive pressures that are stronger than projected.

S&P Capital IQ's views on stocks are constantly re-evaluated. Please refer to our most recent publication on this stock to see our current view.


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