Due to the significant "external growth" characteristics of $Barnes(B.US)roadcom.US, Dolphin has focused on sorting out the company's history of external mergers and acquisitions in the previous article. Broadcom has consistently followed a growth path of "external acquisition - internal integration - external acquisition," evolving from a "semiconductor division" to one of the top five semiconductor companies globally.

From the previous article ("Broadcom: Is 'Buy, Buy, Buy' paving the way for a trillion-dollar future? Tencent and Alibaba should take notes!"), it can be seen that when the company's "total debt/LTM adjusted EBITDA" ratio is reduced to around 2 or below, it begins to initiate a new round of acquisition activities. Currently, after acquiring and consolidating VMware, the relevant ratio remains as high as 3.5. The company is in the internal integration phase, with the main focus on streamlining personnel and reducing related expense ratios to enhance the profitability level of the merged company. During the period of organic growth, the focus will primarily be on the performance of the company's own business and the integration of personnel costs.

From the perspective of Broadcom's business development and integration, the company's biggest focus now is on AI revenue and VMware, which are also the main sources of growth for the company at present.

1) AI Business: Leveraging its comprehensive capabilities accumulated over the years, Broadcom has taken the lead in the ASIC field, and the company's collaborative products with Google and Meta have already entered mass production. With the growth of the computing power market and the increasing demand for self-developed chips, the company's AI business is expected to continue to grow rapidly;

2) VMware Business: This comes from Broadcom's recent acquisition, where the company places significant emphasis on the cloud services market and VMware's leading position in the virtual machine market. After completing the divestiture of non-core businesses, Broadcom is adjusting its acquisition model of perpetual licenses to a subscription-based SaaS charging, effectively "raising prices," which further enhances the monetization capability of the company's software business. After the adjustment of the charging model is completed, VMware's growth rate will revert to the overall growth level of the virtual machine industry.

After breaking down the company's core and traditional businesses, Dolphin expects Broadcom's core operating profit for the fiscal year 2025 to reach $33.6 billion, a year-on-year increase of 38%. Due to the impact of business integration in fiscal year 2025, the company continues to expect its core operating profit for fiscal year 2026 to be $40.1 billion, a year-on-year increase of 19%. The current market value ($785.4 billion) roughly corresponds to a PE of 21 times the core operating profit after tax for fiscal year 2026, with a PEG close to 1.

The previous rise in the company's stock price is mainly attributed to the incremental contributions from the AI business and VMware. Combining the PE and DCF methods, the company's operational status generally aligns with the current stock price. Due to the company's role as a "water seller" behind the cloud giants (hardware ASIC chips and software virtual machine services), there is relative certainty in the current industry trend. If there are signs of a systemic pullback in the U.S. tech sector, it will provide better buying opportunities for the company.

Dolphin Jun's specific analysis of Broadcom (AVGO.O) is detailed below:

Broadcom primarily divides its business into two main segments: semiconductor solutions and software services, but the growth points for the company remain relatively unclear in both areas.

Looking at the business in detail, the semiconductor business mainly includes networking, storage connectivity, broadband, wireless communications, and industrial and other sectors;

In the software services segment, it mainly consists of the newly acquired VMware and the existing CA, Symantec, and Brocade. After the acquisition and consolidation of VMware, the company's current largest revenue sources come from networking and VMware businesses, which together account for 60% of total revenue.

Currently, the market's main focus regarding Broadcom is on the AI business within the networking segment and the integration of VMware, which are also the company's most important incremental parts. Before estimating performance, Dolphin Jun will first introduce the situation of these two business segments.

1. AI Business

The AI business is a major highlight of Broadcom's semiconductor segment, and the company categorizes this revenue under networking. Based on a comprehensive product system, Broadcom can provide many services beyond CPUs in the cloud service computing power cluster, including custom ASIC chips (XPU), switching chips, PHY chips, etc.

Specifically: 1) Computing segment: processing unit architecture (provided by customers), design process and performance optimization (Broadcom); 2) Memory segment: HBM PHY chips and integration (Broadcom); 3) Network I/O segment: network I/O architecture and related (Broadcom); 4) Packaging segment: 2.5D, 3D, and silicon photonics architecture (Broadcom).

1.1 The Situation of ASIC Chips in the Computing Power Market

Affected by the laws of physical scaling, manufacturing processes are approaching physical limits, and the speed of chip performance improvement is slowing. Due to the slow improvement of GPU performance per unit area (TFLOPS/mm^2), performance is mainly enhanced by increasing area (such as NVIDIA's B200, etc.). Thus, abandoning some general functions in GPUs and focusing on performance enhancement for specific scenarios with ASIC chips is a way to improve performance and reduce power consumption.

Although current cloud service providers mainly procure GPUs from NVIDIA and AMD, major companies like Google, Meta, Microsoft, and Amazon are also developing their own ASIC chips. As for the layout of ASIC chips by these major companies, Dolphin believes the main reasons are: 1) having self-developed technology, which is relatively not constrained by other manufacturers; 2) under equivalent computing power, they can achieve better cost and power consumption performance. However, self-developed ASICs will also face issues such as IP and industrial chain integration, and they generally choose to collaborate with companies like Broadcom and Marvell for chip design.

From the information disclosed by the company, Broadcom's current AI revenue mainly comes from Google and Meta, both of whose ASICs have already entered mass production, with the largest portion coming from Google's TPU.

Since its first generation, Google's TPU has evolved to the latest TPU v6e, which will be released in 2024. In terms of FP16/BF16 precision, Google TPU v6e can achieve 926 TFLOPS, approximately 93% and 53% of H100 and B100 (non-sparse computing power metrics), respectively. NVIDIA's H100 was released in 2022, so Google's TPU is roughly two years behind in computing power.

From the current release information, Google's latest TPU v6e is mainly intended for training and inference integration, and the company is expected to launch TPU v6p, specifically for larger-scale foundational model training tasks. Currently, the versions mainly used for large-scale training are still v4 and v5p, and the TPUs deployed by Google are primarily used to support its internal projects like Gemini, Gemma, and Search, as well as workloads for external clients like Apple. Previously, Apple disclosed that its cloud-side AI foundational model was trained on 8192 TPU v4 chips, while the edge-side AI model was trained on 2048 TPU v5p chips.

1.2 Broadcom's AI and Network Business Situation

Since Google is a major customer of the company's current AI business, we will compare Google's capital expenditure with the company's AI business revenue: starting from the end of 2023, Google's capital expenditure has significantly increased, and at the same time, Broadcom's AI business revenue has also doubled. Overall, the growth trend of Broadcom's AI revenue is roughly in line with the changes in Google's capital expenditure.

Additionally, from the chart below, it can also be seen that the growth rate of Broadcom's AI business is higher than the growth rate of Google's capital expenditure. Dolphin believes: 1) Currently, Google has increased the proportion of self-developed TPUs in its cloud service infrastructure; 2) Meta's ASIC chips have also entered mass production in 2024.

As both of the company's major AI clients have already achieved mass production, the capital expenditure of Google and Meta will directly impact the company's AI revenue. Based on calculations, the current ratio of Broadcom's AI revenue to the combined capital expenditure of the two companies is approximately 15%.

If the company's network business is divided into AI revenue and non-AI revenue, it can be seen that AI revenue is showing rapid growth, while non-AI revenue has declined. Considering the company's and industry's situation, Dolphin expects that the capital expenditure of the two major companies will still maintain a growth level of over 30% next year, and will further increase the share of self-developed chips in cloud service infrastructure. Broadcom's AI revenue in the fiscal year 2025 is expected to exceed $17 billion, with a year-on-year growth rate of over 40%. Although non-AI revenue remains sluggish, driven by the AI business, the company's overall network revenue is expected to grow to over $20 billion, with a year-on-year growth rate of over 30%.

2. VMware Business

Broadcom's software business mainly includes virtualization software, mainframe software, distributed software, network security solutions, and storage network management software, but essentially all of the company's software business comes from acquisitions. The virtualization software comes from VMware, the mainframe software comes from CA, and network security and storage network management come from Symantec and Brocade, respectively.

From the changes in Broadcom's total software service revenue, although each business basically comes from external acquisitions, the company has achieved stable growth through integrated management. The significant revenue increase in 2024 is mainly due to the consolidation of VMware.

Currently, the market is most concerned about the consolidation situation of the newly acquired VMware. In November 2023, Broadcom completed the acquisition of VMware, offering a premium of over 40%, with a valuation of $69 billion, which includes a purchase price of $61 billion (cash + stock) and the assumption of VMware's net debt of $8 billion.

After the acquisition was completed, Broadcom reformed VMware: 1) Adjusting the company's original software sales model to a SaaS and subscription model; 2) Reducing the scale of distributors to connect directly with customers; 3) Divesting non-core businesses such as EUC (End User Computing) and endpoint protection. The acquisition initiated by Broadcom mainly focuses on VMware's industry position in virtualization software and the opportunity for business integration.

2.1 Virtual Machine Market Situation

Through server virtualization, multiple virtual machines run concurrently on the same physical server, maximizing hardware resource utilization, reducing the number of physical servers, and facilitating management and maintenance. Currently, cloud service providers (such as Amazon, Microsoft, Google, etc.) widely use virtualization technology and are all major customers of VMware The company originally started with server virtualization products and later expanded its business into storage virtualization, network virtualization, and computing virtualization.

Broadcom's acquisition of VMware is partly driven by the prospects of the virtual machine business in the server market. VMware itself is a leading enterprise in the virtual machine market. According to the State Administration for Market Regulation of China, in 2021, the company's market share in the global and domestic non-public cloud virtualization software market was 92-97% and 22-27%, respectively.

In addition to cloud service providers being major customers of VMware, the company has acquired customers through partnerships with major cloud vendors and entering the cloud service markets of these IaaS providers (such as the collaboration with AWS in 2016 to launch VMware Cloud on AWS).

According to VMware's official website, the current number of VMware users worldwide has exceeded 300,000. Among the Fortune Global 50 companies, over 58% have adopted VMware's services.

2.2 VMware's Virtual Machine Business

VMware's virtualization software is primarily used to run multiple operating systems simultaneously on the same physical computer. This can be used for both personal users and commercial purposes such as servers, with the company launching VMware Workstation Pro and VMware Workstation Player.

Currently, the company's flagship product "VMware Workstation" is a mature virtualization solution that can run multiple operating systems on a single computer. It is suitable for 64-bit Windows and Linux host operating systems and supports traditional x86 architecture hardware equipped with 64-bit Intel and AMD CPUs. As this is a virtual machine solution developed over 20 years, its stability and reliability have been widely validated, making it suitable for various use cases such as personal and enterprise desktop virtualization, development, and testing.

Compared to Oracle's VirtualBox, both can handle lightweight tasks. However, under higher workload requirements, VMware's performance is significantly better than its competitors. In a Windows 11 operating environment, each test allocated 8 vCPUs and 24GB of memory to the Ryzen 5 5600X, and VMware's response speed was noticeably better than that of VirtualBox.

With its leading product capabilities and market position, VMware has significant bargaining power. Therefore, after Broadcom's acquisition of VMware, it further promoted the transition from a perpetual license fee model to subscription and SaaS services, which is essentially a disguised "price increase." This is similar to Microsoft's Office 365, where the previous Office was purchased with a CD key model, but has now transitioned to a subscription-based SaaS model on an annual/monthly basis. VMware has also shifted from a one-time purchase fee to annual/monthly charges.

After Broadcom divested its non-core businesses such as EUC, VMware's revenue mainly consists of subscription SaaS fees and licenses. In the third quarter of 2023, VMware went public, and for the sake of consistency in estimation, Dolphin Jun only included "licenses + subscription services" in VMware's revenue before going public.

As seen in the chart below, business steadily grew in 2023 and prior, while starting in 2024, VMware's subscription + license revenue surged, mainly due to the company's adjustment of its pricing policy. The ability to raise prices by 200-400% post-acquisition, although displeasing to customers—including AT&T, which even sued the company—ultimately ended in a settlement, reflecting VMware's bargaining power in the industry.

Due to the company's current software business, which mainly consists of VMware and the original businesses of CA, Symantec, and Brocade, Dolphin Jun believes that the original software business will remain stable. The market is focused on VMware, which is expected to continue benefiting from the "price increase" policy. As perpetual license services gradually transition to subscription-based SaaS services, VMware's medium to long-term growth rate will revert to around the growth rate of the virtual machine industry (approximately 10%). Driven by the shift to subscription-based SaaS services, VMware's revenue for Broadcom in fiscal year 2025 is expected to exceed $17 billion, a year-on-year increase of 40%.

3. Broadcom's Performance Estimation and Valuation

From Broadcom's business structure, the company consists of semiconductor solutions and software services. In the aforementioned article, Dolphin Jun mainly outlined the AI business and VMware business, which are of greatest concern to the market, but the company also has other business segments.

3.1 Revenue Side

1) Semiconductor Solutions: In addition to the largest segment, networking, the company also has storage connectivity, broadband, wireless communication, and industrial and other businesses. ① Storage connectivity business is expected to see a slight recovery in fiscal year 2025 due to storage cycle impacts; ② Broadband business is expected to remain relatively sluggish in fiscal year 2025 due to investments from telecom and broadband operators; ③ Wireless communication business mainly provides RF front-end and WiFi chips, with Apple as the main customer. Due to the influence of Apple and the electronics product cycle, a slight rebound is expected in fiscal year 2025; ④ Industrial and other segments account for a small overall business proportion, with an expected improvement in fiscal year 2025. Overall, Broadcom's semiconductor solutions business revenue is expected to reach $35 billion in fiscal year 2025, a year-on-year increase of 17%. 2) Software Business: ① Existing Business Segment (CA & Symantec & Brocade) is expected to remain stable with slight improvement in FY2025; ② VMware Business, under the influence of price adjustment policies, will continue to grow rapidly in FY2025; Overall, Broadcom's software business revenue is expected to reach $27 billion in FY2025, a year-on-year increase of 25%.

3.2 Gross Margin and Operating Conditions

1) Gross Margin: Due to the company placing part of the acquisition-related expenses on the cost side, this directly affects the company's gross margin data. Dolphin believes that excluding this impact provides a clearer picture of the company's operating conditions. Therefore, when forecasting gross margin, Dolphin primarily uses the figure after excluding these expenses.

The gross margin of the software business (operating side) is expected to continue to rebound after the adjustment of charging policies. Although the gross margin of the semiconductor business (operating side) remains relatively low, driven by the increase in software revenue proportion, the overall operating gross margin of the company in FY2025 is expected to continue to improve;

2) Operating Expense Ratio: Considering the company's past acquisition integration, the company will continue to control expenses and reduce the expense ratio. The management has also clearly stated that it will continue to streamline personnel expenses. It is expected that the R&D expense ratio and sales expense ratio will continue to decrease in FY2025;

3.3 Operating Profit Situation

With the company's revenue growth, recovery of operating gross margin, and reduction in operating expense ratio, it is expected that Broadcom's core operating net profit in FY2025 will reach $33.6 billion, a year-on-year increase of 38%.

For the expectations after FY2025, the capital expenditure growth rate of companies like Google and Meta is expected to decline but remain around 20% compound annual growth; at the same time, with the steady increase in the proportion of self-developed ASIC chip usage, Broadcom's AI revenue is still expected to achieve a compound growth of over 20%. VMware's growth rate is expected to fall to the industry growth rate level, with a compound growth rate of 12.6%. The traditional businesses and gross margins of other companies remain relatively stable, and the company's two expense ratios are expected to drop below 20%.

Under the above expectations, Broadcom is expected to basically complete price adjustments and business integration in FY2025. The company's core operating net profit in the subsequent FY2026-2028 is expected to reach $40.1 billion / $45.1 billion / $49.5 billion, with a compound growth rate of 13.9% during this period.

3.4 Valuation Level

1) From the PE Perspective

Due to Broadcom's acquisition of VMware at the end of 2023 and its subsequent consolidation, the profits in the company's recent reports have been affected by acquisition amortization and other factors, making it difficult to directly observe the company's operating conditions. Dolphin will analyze the core operating profit extracted from the company's reports: Core Operating Profit = Revenue * Operating Gross Margin - R&D Expenses - Selling and Administrative Expenses

From the above calculations, it can be seen that Broadcom's core operating profit for the fiscal year 2025 will reach $33.6 billion, a year-on-year increase of 38%. Considering the company's historical income tax rate of around 7%, the current market value (USD 785.4 billion) corresponds to an estimated valuation of approximately 25 times PE for the core operating profit after tax for the fiscal year 2025.

As the company's business integration is basically completed after the fiscal year 2025, it will enter a period of stable growth. Based on previous expectations, Broadcom's core operating profit for the fiscal year 2026 is projected to be $40.1 billion, a year-on-year increase of 19%. The current market value corresponds to a PE of about 21 times after tax for the fiscal year 2026, with a PEG close to 1.

2) From a DCF Perspective

Due to the current company's acquisition of VMware, there will be significant amortization, which will affect the company's profits. However, after the fiscal year 2028, this impact will weaken, and the company's profits will gradually improve. According to the DCF valuation method, assuming a perpetual growth rate g=3% and WACC=11.55%, the valuation is $804.6 billion, equivalent to $172 per share.

3) Comprehensive View

The previous rise in the company's stock price is mainly attributed to the incremental boost from AI business and VMware. Considering the PE and DCF methods, the company's operational status is basically in line with the current stock price. As the company plays the role of a "water seller" behind the major cloud providers, there is relative certainty in the industry trend. If there are signs of a systemic pullback in the U.S. tech sector, it will provide better buying opportunities for the company.

Dolphin Investment Research Broadcom Related Articles Review:

In-depth:

September 13, 2024, Company In-depth: Broadcom: "Buy Buy Buy" Paving the Way for "Trillions"? Tencent and Alibaba Take Note!

Earnings Report:

September 6, 2024, Conference Call: Broadcom: Demand for ASICs Will Be Greater in 2025 (FY24Q3 Conference Call)

September 6, 2024, Earnings Report Commentary: Broadcom "Surging"? AI Can't Support the Collapse of Traditional Semiconductors

Risk Disclosure and Statement of this Article: Dolphin Investment Research Disclaimer and General Disclosure