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Should Broadcom Investors Worry About the Toshiba Unit Deal?

Zacks Equity Research

Broadcom Limited AVGO is one of the four companies whose bids are being considered for the sale of Toshiba’s NAND memory-chip unit. Broadcom made the highest first-round bid of $23 billion. Other shortlisted companies include Western Digital WDC, Korea’s DRAM maker SK Hynix and the Foxconn unit of Taiwan’s Hon Hai Precision.

Broadcom has partnered with private-equity firm Silver Lake and three Japan banks - Mizuho Financial Group Inc., Sumitomo Mitsui Financial Group Inc. and Mitsubishi UFJ Financial Group Inc. to finance the deal.

However, the development failed to cheer investors as the stock was down almost 4% at the close of trade on Wednesday.

Broadcom Limited PE Ratio (TTM)

Broadcom Limited PE Ratio (TTM) | Broadcom Limited Quote

Western Digital Casts Cloud Over Broadcom’s Success

Western Digital is Toshiba’s joint venture partner and possesses rights to approve or disapprove any transaction that involves the partnership. In fact, Western Digital is particularly against Broadcom as far as this sale is concerned.

Western Digital Chief Executive Officer Steve Milligan wrote a letter to Toshiba’s board members on Apr 9 advising them to negotiate exclusively with Western Digital before any sale.

Milligan reportedly argued that the current bidders are problematic and that the price is too high to reflect the fair value of the chip business. He was particularly against accepting the bid from Broadcom.

Western Digital appears to be using its partnership with Toshiba to keep Broadcom away from the deal. It cited concerns based on its recent commercial dealings with Broadcom as the reason behind taking the stand against the company.

Should Investors Worry

Western Digital’s interference has certainly complicated the bidding process particularly around Broadcom. 

We believe the recent drop in Broadcom’s share price is due the fact that investors are skeptical about the company’s ability to crack the deal and prefer to wait for the turmoil to finish before they make any investment decisions.

We believe Broadcom stock will regain its pace as the situation stabilizes and can still be a part of your portfolio.

Impressive Track Record of Growth

Broadcom’s extensive product portfolio, which serves multiple applications within four primary end markets, places it in a position to gain significant market share going ahead.

The company’s strong relationships with leading OEMs across multiple target markets mitigates operating risks,  lessens the exposure to volatility in any single market and helps it to gain key insight into the requirements of customers. This helps it to be more efficient and productive when it comes to catering to the target markets and customers.

In addition, the company maintains an efficient global supply chain with a variable, low-cost operating model. The company outsources the majority of its manufacturing operations, assembly and test capabilities, as well as some of its corporate infrastructure functions. Broadcom also aims to minimize capital expenditure by focusing on internal manufacturing capacities; leveraging innovative materials and processes to protect intellectual property rights and outsourcing standard CMOS processes. These enable the company to maintain sustainable revenue growth and expand margins.

Acquisitions, over time, have been Broadcom’s most favored mode of penetrating unexplored markets.

Over the past three months, Broadcom has impressed investors with its share price surging 15.9% compared with the Zacks Electronics - Semiconductors industry’s gain of 13.9%. An impressive track record of growth backed this rise.

Consistent Dividend Payout

Broadcom generates significant cash flow ($3.41 billion in fiscal 2016) that enables it to pay consistent dividend payment. The company paid aggregate cash dividends of $716 million, $408 million and $284 million during fiscal year 2016, 2015 and 2014, respectively. Due to strong and relatively stable cash flow, the dividend payout appears sustainable and makes the stock quite attractive.

Positive Estimate Revisions

In the past 60 days, five estimates for the current quarter moved north while none moved south. Estimates increased from $2.71 a share 60 days ago to $3.01 per share currently, an increase of 11.1%.

Meanwhile, the current year estimate revision trend is also looking encouraging, with five estimates moving north in the last 60 days and none moving south. The Zacks Consensus Estimate also increased from $12.09 per share 60 days ago to $12.91 per share currently, an increase of 6.8%.

This has helped Broadcom to sport a Zacks Rank #1 (Strong Buy), further highlighting the company’s solid position. You can see the complete list of today’s Zacks #1 Rank stocks here.

Industry Rank in Positive Territory

The Zacks Industry Rank is a very good indicator of investment opportunities within an industry at any given time. Per the Zacks methodology, the outlook for industries positioned #88 or lower is Positive, between #89 and #176 is Neutral and #177 and higher is Negative. Broadcom is thus in the positive territory with a Zacks Industry Rank # 74.

Other Picks

Top-ranked stocks in the broader technology space include Micron Technology, Inc. MU and Square, Inc. SQ, each sporting a Zacks Rank #1 (Strong Buy). Projected long-term growth rates for Micron and Square are 10% and 22.5%, respectively.

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