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Morningstar | Broadcom Kicks Off Fiscal 2019 With Impressive Cash Flow Generation, but Debt Bears Watching. See Updated Analyst Note from 15 Mar 2019

Against a backdrop of weakness and uncertainty in the semiconductor space, Broadcom turned in solid fiscal first-quarter results thanks to the addition of CA Technologies as well as broad-based strength in its semiconductor business, excluding wireless. Although Broadcom has suffered near-term share loss at leading smartphone vendors such as Apple and Samsung, causing overall semiconductor solutions revenue to be down year over year, management reiterated its view that the overall segment will experience a second-half rebound thanks to regained share and upcoming product cycles in wireless and networking, respectively. CFO Tom Krause also maintained the firm’s revenue outlook for the year at $24.5 billion, which corroborates with the expectation of a second-half recovery consistent with the likes of Intel. The shares rose 5% during after-hours trading and are approaching our unchanged fair value estimate of $300. All in, we think prospective investors would find a more attractive margin of safety in wide-moat Intel rather than narrow-moat Broadcom, though the latter would look more appealing on a pullback.

Broadcom now discloses only two reporting segments (semi solutions and infrastructure software) as well as annual guidance versus quarterly. First-quarter revenue was $5.8 billion, up 9% year over year and 6% sequentially. Semi solutions sales were $4.4 billion, down 12% year over year due to the aforementioned wireless weakness that is plaguing the rest of the industry. Concerning 5G, CEO Hock Tan doesn’t see material content uplift until beyond 2020, given that the attach rate this year and next year in handsets will still be very low, particularly for content related to RF (FBAR filters), antenna, and other parts on which Broadcom focuses. Tan noted that the semi business was actually up year over year excluding wireless, with networking up double digits.

We anticipate the strength in networking to persist throughout the year as its latest products (including the Tomahawk 3 switching platform and Jericho 2 router) continue to ramp at major data center customers including Google and Amazon. Infrastructure software sales were $1.4 billion, up from $328 million during the same period in fiscal 2018 due to the inclusion of CA. Broadcom’s structural alteration of CA’s business model from one of perpetual licenses to a fully ratable subscription model to better compete with SaaS alternatives is on track, per Tan, though we note it will still take close to two years before this transition really hits its stride and we see meaningful growth and operating margin expansion for the subunit.

Although Broadcom’s fiscal first quarter is typically the seasonally weakest cash flow quarter due to its annual performance bonus payment made to its employees during the period, the firm had record first-quarter free cash flow from operations of $2.0 billion, up 39% year over year. For fiscal 2019, Krause expects $10 billion in free cash flow from continuing operations. Exiting the first quarter, Broadcom held $5.1 billion in cash and equivalents versus $37.6 billion in total debt. While this net debt position is exorbitant, we think the Broadcom's strong cash-flow-generation capabilities remain sufficient to meet future debt obligations, and we expect the firm will work down its debt level before reverting to its proclivity for mergers and acquisitions. Underscoring management’s confidence in Broadcom’s cash-generation capabilities, the firm plans to pay out over $4 billion in cash dividends and buying back a total of $8 billion of stock in fiscal 2019. While we remain positive on Broadcom’s powerhouse networking, RF filter, and connectivity portfolios, we believe the net debt level deserves scrutiny going forward.