Can Broadcom Bounce Back?

After a 12% drop on a 5% guidance reduction in April, analysts and investors are starting to see Broadcom Corp. (Nasdaq: BRCM) as a value opportunity. Last week, Broadcom, a manufacturer of semiconductors for wired and wireless communication, even led the IU25 index following positive analyst attention. Let's take a closer look at the outlook and numbers to determine whether this is a buying signal, or just a brief pause on a long-term decline.

Compared to direct competitors Qualcomm Inc. (Nasdaq: QCOM) and Texas Instruments Inc. (NYSE: TXN), Broadcom has a slightly lower gross margin on chipset manufacturing because it has fewer economies of scale. It also suffers from volatile profitability because of its concentrated niche and sales cycle timing from its largest customers, which make up a significant portion of its revenues.

That said, Broadcom is the leader in its niche (wireless LAN chipset manufacturing) -- and that niche is becoming increasingly popular in a wide variety of consumer electronics, including smart phones, cable and DSL modems, cameras, and personal computers. Expected long-term market growth for this type of chipset positions Broadcom very favorably for steady growth.

Walking through a discounted cash flow (DCF) valuation of Broadcom, I arrived at a one-year price target of $43.87, just under consensus valuation of $45. Let's look at some of the key components and assumptions in my model:

This graph is a time-stretch of a baseline-to-optimistic valuation range. If everything goes well over time, Broadcom's valuation would play out to $48.67 a share, while generating mediocre results would land it closer to $43.87. The buy/sell bands are a function of the stock's price volatility, to help us identify entry and exit points.

I usually assume mean FY1 revenue estimates as a baseline for revenue growth, unless there is an extraordinary, material item that I deem unlikely to affect long-term sales. For this model, I'm using the mean estimate.

Growth can be the five-year GRE (15.6%), but I'm going to widen that number into a range of 9.8% to 19.4% to account for competitor and technology risk and niche positioning upside. My driving margin (free cash flow) incorporated a range of 4.25% to 16.3% based on historical results.

Adding cash, subtracting debt (net $1.55B), and discounting back at 10.5%, I arrive at a present value market cap of $25.3 billion to $28.1 billion. Divide by the diluted share count of $575 million, and I arrive at a valuation range well above current price levels.

Based on the positive outlook and confirmed by the valuation model, it seems like a good time to acquire Broadcom shares. Since the stock is near its recent bottom, you'll be able to maximize your potential return while minimizing your risk of loss.