It's my guess that these guys like having an expensive stock price, kind of a power trip...
Here's a pretty good piece from Wired,
Fish or Cut Bait: Betting on Broadcom
By Paul R. La Monica
Redherring.com, August 21, 2000
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Unless you're addicted to CNBC and its what-have-you-done-for-me-lately mentality, this spring's tech-stock slaughter created some fantastic opportunities for long-term–oriented investors.
Careful searching allows you to find some quality tech companies that aren't nearly as absurdly valued as they were before. I've highlighted a number of such companies in the past few weeks, companies like Ariba (Nasdaq: ARBA), Commerce One (Nasdaq: CMRC), Priceline.com (Nasdaq: PCLN), Worldcom (Nasdaq: WCOM), and Broadvision (Nasdaq: BVSN).
Accordingly, I wanted to find a stock that wasn't such a good value. I picked Broadcom (Nasdaq: BRCM), which makes chips for cable modems and set-top boxes. After all, it's trading at 267 times estimated 2000 earnings, and it has a market cap exceeding $50 billion (despite having been public for only two years), and it seems to make dilutive acquisitions each week.
So I figured it must be overvalued.
FUNDAMENTALLY SOUND
But guess what? I couldn't find anything fundamentally wrong with this company. As a matter of fact, I think it would be foolish to shy away from Broadcom simply because it has a high price-to-earnings ratio. Here's why.
Market leaders trade at substantial premiums to their competitors and the market at large. That's just the way it is. Some things will never change. (The first person to email me with the author of that song lyric will get a nice big shout-out in next week's column.) Look at Cisco Systems (Nasdaq: CSCO) and Sun Microsystems (Nasdaq: SUNW), for example. I think Broadcom -- despite its brief history as a public company -- has to be lumped into this category as the preëminent communications chip maker.
Broadcom has gone from having just $37 million in revenue in 1997 to having $437 million in the first half of this year. Analysts predict that Broadcom will crack the $1 billion revenue mark this year. That's just amazing. Keep in mind, the knock on many young tech companies is that they get immediately rewarded with mega market caps, even though many of them have no earnings and in some cases (e.g., Corvis (Nasdaq: CORV)), no revenue.
But Broadcom, like some mini-Cisco, has fueled its rapid growth through some very astute acquisitions. It's made three in the past three weeks: $533 million for Altima Communications, $1.2 billion for Silicon Spice, and $1.24 billion for Newport Communications.
By the way, all three deals were announced on a Monday. And because most of you will be reading this on a Monday morning, you might want to check the headlines to see if today is just another manic merger Monday for Broadcom. If it is, odds are the stock will go up -- that's right, up.
Broadcom jumped 5 percent after it announced the Altima deal, 4 percent after buying Silicon Spice, and 7 percent after scooping up Newport. Broadcom is up about 13 percent in the past three weeks, despite agreeing to issue nearly $3 billion in stock in these deals, which likely will have a slight dilutive effect on earnings in the near term.
SMART ACQUISITION STRATEGY
Why is this happening? For one, all of Broadcom's targets have been private companies. Typically, the stock of an acquirer will go down because arbitrageurs short-sell the stock of a buyer while purchasing the stock of the target. But because Broadcom has been scooping up companies that have no stock of their own, there's really no reason for the arbs to short it.
From a strategic standpoint, the deals make a ton of sense. Peter Andrew, an analyst with A.G. Edwards, says the two most recent deals in particular will help Broadcom continue its diversification efforts. Silicon Spice makes chips that speed the transmission of voice, video, and data over telecommunications networks, whereas Newport focuses on the feverishly hot area of fiber optics. Ka-ching!
The broadening of Broadcom's product line is the main reason that Mr. Andrew thinks Broadcom's valuation, although it is extremely steep, can be justified. "How many companies are growing 100 percent year over year and have the promise to go into even higher growth areas? Broadcom has come this far without fiber optics," he notes.
What's really interesting to look at with this stock is how sharply it has bounced back since what I call "Tech-Stock Spring Cleaning 2000." The stock was trading at $243.06 on March 10, the day the Nasdaq peaked. It's now at about $246.
CHEAPER AFTER THE CRASH
Although the price has risen slightly, on a valuation basis, the stock is actually cheaper now. According to investment data provider Baseline, analysts were predicting in March that Broadcom would earn 71 cents a share this year. But with the company beating estimates solidly in the first and second quarters, estimates have increased substantially, to 91 cents a share. That's a 28 percent increase, and the stock price is virtually the same as back in March. And earnings estimates for next year have increased by 38 percent since March. Granted, Broadcom still trades at a heady P/E of 192 times 2001 estimates, but back in March its P/E on 2001 estimates was 261.
And analysts can comfortably raise their estimates for the company because the stock has consistently beat expectations for the past four quarters. Most recently, Broadcom reported a 21 percent positive earnings surprise for the June quarter. In a stock market still replete with hope and hyperbole, it is nice to own companies like Broadcom, which repeatedly live up to the Street's expectations.
Broadcom really appears to be in a sweet spot right now. And Michael Sutton, who manages three growth funds for mutual fund firm PBHG, says the high stock price is a blessing, because it allows Broadcom's CEO, Henry Nicholas, to continue scouring for new deals. As of June 30, Broadcom was a top-ten holding in two of Mr. Sutton's funds: PBHG Large Cap 20 (Nasdaq: PLCPX) and PBHG Select Equity (Nasdaq: PBHEX). And it's already hard to find a competitor that has everything Broadcom has to offer. "It's like you're running a marathon, and you're at the beginning and [Mr. Nicholas] is at mile 20," Mr. Sutton says.
Companies that compete with Broadcom in at least one area are Texas Instruments (NYSE: TXN) on the cable modem side, PMC-Sierra (Nasdaq: PMCS) in voice transmission, and on the optics side, Applied Micro Circuits (Nasdaq: AMCC) and Vitesse Semiconductor (Nasdaq: VTSS).
And to be honest, I think these stocks are interesting too, in part because they're a little cheaper (although PMC-Sierra and Applied Micro Circuits also sport triple-digit multiples). I favor a strategy of buying a basket of leaders in a given sector, as opposed to trying to pick one eventual winner. And several of these stocks, including Broadcom, have found their way into the Fish Or Cut Bait Reader Index, which I plan on writing about in next week's column. |
