When Will Broadcom's Shares Recover?

When Will Broadcom's Shares Recover?

Last July, shares of Broadcom took a beating following a less-than-stellar earnings report. However, it wasn't just the worse-than-expected numbers that were the problem at the time, but concerns over Broadcom's connectivity business as well as progress in cellular platforms. Since then, the stock hasn't quite yet recovered to its $37-per-share highs, but it has recovered quite nicely from its lows.

What are investors looking for?
Broadcom's business is split up into three main operating segments: mobile & wireless, infrastructure, and broadband. The infrastructure and broadband businesses are extremely profitable in their own rights, and the connectivity portion of the mobile & wireless business is also quite profitable. Unfortunately, as Broadcom has invested more aggressively in complete cellular platforms, the operating profitability of the division has tanked, with operating margin just shy of 4% in the most recent quarter.

Add to that fears that Broadcom's much larger competitor, Qualcomm , is set to gain some pretty serious connectivity share, and you have a recipe for Wall Street essentially writing off the mobile & wireless business. If Broadcom can provide fairly compelling evidence that this business is going to return to strong profitability, then the stock could command a meaningfully higher multiple than it does today on the expectation of more robust earnings growth.

But wait -- Broadcom trades at a pretty high P/E!
According to Google Finance, shares of Broadcom trade at a whopping 43.67 times earnings. However, this represents GAAP earnings, which includes things like one-time non-cash charges and share-based compensation. Back in that painful July quarter, Broadcom took a $501 million non-cash impairment charge on the acquisition of NetLogic.

What exactly is an impairment charge? So, when a company purchases another company for a specific value (in this case, Broadcom paid $3.7 billion for NetLogic), the purchase price is often determined based on how much money the target company expects to earn over a given period of time.

If at some point after the acquisition it becomes clear that the company won't earn as much as thought, then obviously the asset is worth less than what was paid for it -- requiring the company to take a "loss" on the excess amount paid. Broadcom acquired NetLogic in 2011 and by Q2 2013 it was clear that Broadcom had overpaid, thus it took a writedown, which according to GAAP translates into a hit on net income.

Ex-NetLogic Broadcom isn't expensive
With 581 million shares outstanding, the $501 million charge translates into a hit of $0.86/share. Add this back to the current GAAP EPS number of $0.73 and all of a sudden this 43.67 P/E stock becomes a 20 P/E. If you exclude stock-based compensation as well, then the stock looks even cheaper, although some may argue that doing so paints an unfairly positive picture.

Is Broadcom still a good value here?
While Broadcom felt like a "no brainer" in the $26-27 range, the shares still do offer value just shy of $32. Of course there are competitive concerns from Qualcomm, Intel (which just rolled out its first 802.11ac low power connectivity combo), and others on the connectivity side of things, and yes the market needs to see a payoff from the heavy mobile R&D investment, but even ex-mobile the company has a good business.

So, the questions you need to ask yourself as an investor are the following:

  • Does Broadcom have a good shot at growing and delivering profit in mobile & wireless (or will it sell the division if it can't)?

  • Are there any catalysts that could drive the stock higher?

It really looks like things get better from here
The answer to the first question, in this Fool's view, is "yes." The answer to the second one -- and this may sound cliché -- is also "yes." Broadcom should benefit from the roll-out of the next generation iPhone/iPad products later this year, as Apple is likely to use higher end/higher ASP connectivity combos in its next generation devices, particularly as the Android competition continues to heat up.

And, of course, expect the roll-out of devices based on Broadcom's integrated apps processor/modem platform to help restore confidence in the company's cellular efforts. Given that Qualcomm owns this market, and given how tough of a time even Intel has had in providing a viable integrated part, success on Broadcom's part could translate into much-improved sentiment toward the mobile & wireless business.

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The article When Will Broadcom's Shares Recover? originally appeared on Fool.com.

Ashraf Eassa owns shares of Broadcom and Intel. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel and Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Originally published