Broadcom "soaring"? AI cannot support the collapse of traditional semiconductors

Broadcom (AVGO.O) released its financial report for the third quarter of the 2024 fiscal year (ending in August 2024) after the U.S. stock market on the early morning of September 6th:

1. Overall Performance: Acquisition is the main source of growth. Broadcom (AVGO.O) achieved a revenue of $13.07 billion in the third quarter of the 2024 fiscal year, a year-on-year increase of 47.3%, in line with market expectations ($13.02 billion). The increase in quarterly revenue mainly came from the consolidation of VMware. Broadcom (AVGO.O) recorded a net loss of $1.875 billion in the third quarter of the 2024 fiscal year, mainly due to a one-time tax provision of $4.5 billion made by the company in this quarter.

2. Business Segments: Software's proportion is rapidly increasing. Looking at the breakdown of the company's business segments, with the consolidation of VMware and the growth of AI, the proportion of the company's software business has increased to 44.4%.

1) Semiconductor Solutions Business: Revenue in this quarter was $7.274 billion, a year-on-year increase of 4.8%, lower than market expectations ($7.411 billion). The traditional business is still struggling in the dark, and the business growth has once again declined, without significant boost from AI demand.

2) Infrastructure Software: Revenue in this quarter was $5.798 billion, a year-on-year increase of 199.6%, better than market expectations ($5.5 billion). The growth mainly came from VMware, while the original software business did not show significant growth.

3. Broadcom's Performance Guidance: The expected revenue for the fourth quarter of the 2024 fiscal year is around $14 billion, lower than market expectations ($14.1 billion). Revenue growth is mainly driven by AI and software business.

Dolphin's overall view: Although the company's financial report this time is not bad in terms of data, it is still not ideal when viewed in detail.

From the data perspective, Broadcom's overall revenue for this quarter met market expectations, and the growth indeed mainly came from the boost of AI. Although the company's guidance for the next quarter of $14 billion falls slightly short of market expectations ($14.1 billion), the difference in data is not significant.

However, upon closer examination of the company's various segmented data, the situation is not ideal. 1) After splitting the company's business, it is found that the growth mainly came from the consolidation and growth of VMware, while the company's original business did not receive significant boost from AI; 2) The largest semiconductor solutions business within the company's original business saw its growth rate decline again this quarter, maintaining single-digit growth at around 5%. Currently, although VMware is benefiting from the growth driven by AI, it has not yet formed a comprehensive boost effect According to Dolphin Jun's calculation, VMware's revenue in this quarter is approximately $3.8 billion. Excluding this revenue, the original semiconductor and software businesses of the company only experienced slight single-digit growth, while the network business, although growing rapidly, is still being dragged down by other businesses.

Regarding the market's focus on AI revenue including ASICs and VMware, it can be seen from the company's communication that the company expects AI-related revenue in the semiconductor business to be around $3.5 billion next quarter, and VMware revenue to be around $4 billion, both of which basically meet market expectations. However, the collaboration with Open AI is unlikely to achieve shipments in the short term. Traditional businesses are still sluggish, and the AI-related businesses that the market is focusing on have not shown any significant outperformance.

At the end of 2023, the company acquired VMware for $61 billion, and today, the company's growth of over $700 billion comes entirely from VMware. The continuous rise in the company's stock price before actually already included the market's expectation of the overall business being driven by AI demand. However, the growth of the original business has yet to improve, and relying solely on the growth brought by acquiring VMware (with an annual revenue volume of approximately $12 billion) is difficult to support the current market value of the company.

For a detailed analysis of Broadcom (AVGO.O)'s financial report by Dolphin Jun, please see below:

I. Overall Performance: Acquisition is the Main Source of Growth

1.1 Revenue End

In the third quarter of the 2024 fiscal year, Broadcom (AVGO.O) achieved revenue of $13.07 billion, a year-on-year increase of 47.27%, meeting market expectations ($13.02 billion). Due to Broadcom's acquisition of VMware at the end of 2023, the company's growth mainly comes from the consolidation of VMware . Excluding this impact, the original business of the company only grew by 4% year-on-year, with growth slowing down.

1.2 Gross Profit End

In the third quarter of the 2024 fiscal year, Broadcom (AVGO.O) achieved a gross profit of $8.356 billion, an increase of 35.56% year-on-year. The growth rate of gross profit is lower than that of revenue, mainly due to a slight decline in gross profit margin.

Broadcom's gross profit margin in this quarter is 63.92%, a year-on-year decrease of 5.53 percentage points. After acquiring VMware, the gross profit margin dropped sharply from 69% to 61.7%, mainly because the company included some acquisition costs in the cost of sales. The recent rebound in gross profit margin over the past three quarters is mainly due to the operational improvement of VMware, with the gross profit margin of software services showing a slight increase.

1.3 Operating Expenses

Broadcom (AVGO.O) had operating expenses of $4.568 billion in the third quarter of the 2024 fiscal year, a year-on-year increase of 97.92%, with a slight decrease in expenses compared to the previous quarter.

Breaking down the specific expenses:

1) Research and Development Expenses: The company's R&D expenses for this quarter were $2.353 billion, a year-on-year increase of 73.27%, with a significant increase in R&D expenses mainly due to the consolidation of VMware. R&D expenses are the largest item in the company's expenses, accounting for 18% of revenue, and have remained relatively stable over the past three quarters.

2) Selling and Administrative Expenses: The company's selling and administrative expenses for this quarter were $1.1 billion, a year-on-year increase of 163.2%. The rapid growth in selling expenses is also mainly due to the impact of acquisitions. There has been a certain decline in the past three quarters, with the current selling expense ratio at 8.41%.

3) Amortization of Intangible Assets from Acquisitions: The company's amortization of intangible assets for this quarter was $0.812 billion, a year-on-year increase of 132%, mainly driven by the acquisition of VMware.

4) Restructuring, Impairment, and Disposal Expenses: The company's restructuring, impairment, and disposal expenses for this quarter were $0.3 billion, a year-on-year increase of 43%. The acquisition of VMware directly led to the increase in related expenses, but these expenses have been slowly absorbed over the past three quarters.

1.4 Net Profit

Broadcom (AVGO.O) recorded a net loss of $1.875 billion in the third quarter of the 2024 fiscal year, mainly due to the restructuring of the supply chain, which resulted in the transfer of certain intellectual property within the group to the United States, leading to a one-time non-cash tax provision of $4.5 billion.

Therefore, it would be more appropriate to look at operating profit for this quarter. The company achieved an operating profit of $3.788 billion this quarter, a year-on-year decrease of 1.76%. The decline in operating profit was mainly due to the increase in acquisition amortization.

II. Business Segmentation: Rapid Increase in Software Proportion

Broadcom (AVGO.O) has two main businesses: semiconductor solutions and infrastructure software. With the completion of the VMware acquisition and consolidation, the proportion of the company's infrastructure software business has significantly increased. The original 80:20 ratio is now close to 1:1, mainly driven by the consolidation of VMware and the demand for AI In the two main categories of business, it specifically includes, 1) Semiconductor Solutions: networking, wireless, storage connectivity, broadband, industrial, and others; 2) Infrastructure Software: VMware, CA, Symantec, Brocade, etc.

2.1 Semiconductor Solutions

Broadcom (AVGO.O) achieved a revenue of $7.274 billion in the third quarter of the 2024 fiscal year for its semiconductor solutions, a year-on-year increase of 4.8%. Compared to the rapidly growing total revenue and software business revenue, the growth of the semiconductor business more reflects the growth of the company's existing business.

With the increasing demand for AI, the market originally expected the company's semiconductor business to accelerate, especially as it is a core chip supplier for companies like Apple, as well as a key supplier for AI data center network switches and ASIC custom chips, which has sparked some market fantasies.

Among the customers of the company's AI ASIC are Google, Meta, and ByteDance, and with the opening of cooperation with Open AI, it is expected to become another major customer for the company in the future. ASIC is also one of the main focal points for the company in the market, currently being the main source of growth for the company's semiconductor business.

However, the company's semiconductor business growth rate has once again declined. Although the company mentioned during the conference call that they believe AI will continue to drive strong demand for hardware and software, the AI revenue in the semiconductor segment is expected to reach $12 billion for the full year, with the total annual revenue guidance being $51.5 billion, accounting for nearly 25% of the total revenue. This further highlights how significant the challenges brought by the downturn in traditional business are for the company. In subsequent discussions, the company expects AI-related revenue in the semiconductor business to be around $3.5 billion in the next quarter, slightly better than market expectations ($3.36 billion). The company currently has three important customers, all of whom have actual shipments.

For AI accelerators, market demand is mainly divided into two categories: companies that are unable to customize chips and large companies that are capable of customizing chips. The company expects that by 2025, the overall market demand for ASICs will continue to increase.

2.2 Infrastructure Software

Broadcom (AVGO.O) achieved a revenue of $5.798 billion in the third quarter of the 2024 fiscal year, a year-on-year increase of 200% in infrastructure software. The rapid growth of the company's software business is mainly attributed to the consolidation of VMware.

According to the company's financial report, Dolphin estimates that VMware's revenue for this quarter is around $3.8 billion, accounting for nearly 30% of the overall revenue. Compared to last year, traditional software business has only slightly improved, with little boost from AI demand.

As for VMware acquired by Broadcom, the focus of its business revenue lies in cloud service subscriptions and the transformation to a SaaS model, with a long-term gross profit margin of over 80%. It is more focused on subscriptions and SaaS, as it mainly charges based on usage or time, resulting in good overall cash flow for the business. VMware itself holds a market share of over 90% in the global non-public cloud virtualization software market.

Source: Internet sources, Dolphin Research Institute

Regarding the decline in software gross profit margin after acquiring VMware, the company responded, "Software gross profit margin is not critical to the company unless it involves large-scale SaaS operations. Although some products are subscription-based, most are not SaaS, and the gross profit margin will still be maintained at around 90%."

For the infrastructure software business, the company expects revenue of $6 billion in the next quarter. Due to the relative stability of the existing software business, Dolphin speculates that VMware's revenue in the next quarter will be around $4 billion, which is basically in line with market expectations ($3.84 billion). The company's current focus remains on the transformation and integration of VMware, with no other acquisition plans at present.