Broadcom boosted AI revenue outlook for the year from $11 billion to $12 billion. Based on the forecasted $51.5 billion in revenue in fiscal 2024, AI is expected to contribute more than 23% of Broadcom’s revenue this year.
During the CEO’s opening remarks, more information about Q3’s AI revenue and Q4’s AI revenue was provided: “AI demand remains strong and we expect, in Q4, AI revenue to grow sequentially 10% to over $3.5 billion. This will translate to AI revenue of $12 billion for fiscal '24, up from our prior guidance of over $11 billion.” The issue is that AI revenue was flat QoQ compared to being up 35% QoQ last quarter.
Overall, Q3 did beat yet Q4’s guide was a bit light, with Broadcom forecasting revenue of $14 billion next quarter versus consensus for $14.04 billion. Semiconductor solutions revenue growth also missed growth forecasts with YoY growth of 5%, while estimates from Oppenheimer expected 7% growth.
The stock is priced to perfection, and we do not think this earnings report is not enough to sustain the valuation. We discuss this and more below.
Revenue
Broadcom beat Q3’s revenue estimates marginally and was one percent ahead of consensus estimates, compared to a nearly 4% beat last quarter. Q4 was also guided slightly below analyst estimates.
- Q3 revenue was $13.07 billion for YoY growth of 47.3%, accelerating 430 bp from 43% YoY growth in Q2. Excluding VMWare’s contribution, YoY growth was 4%.
- For Q4, management guided for $14 billion in revenue, for YoY growth of 50.6%, marking another 330 bp acceleration, but short of the 51% growth estimate from analysts.
- For FY24, management did not provide an updated revenue guide, with the previous guidance provided of $51 billion. However, given Q4’s guide, revenue for FY24 is projected to be $51.5 billion.
As probably the most-closely watched (and most anticipated) figure, AI revenue for FQ3 was $3.1 billion, flat QoQ. Through Q3, AI revenue totaled $8.5 billion. For fiscal 2024, Broadcom increased its AI revenue outlook to $12 billion, a 20% increase from $10 billion in Q1 and another $1 billion increase from last quarter’s view for $11 billion. The increased outlook is driven by strong growth for Ethernet and ASICs, and implies Q4 AI revenue of $3.5 billion, up nearly 13% QoQ.
The issue that remains is, will this AI revenue be enough to justify the valuation (in the near term)?
Key Segments
Semiconductor solutions revenue was $7.27 billion, increasing 5% YoY and 1% QoQ. This was a 100 bp deceleration from 6% YoY growth last quarter, while also falling short of estimates, with some analysts expecting growth of ~7% YoY and 2% QoQ.
- Networking grew 43% YoY to $4 billion. Ethernet switching, driven by Tomahawk 5 and Jericho3-AI grew over 4x year-on-year. We’ve covered these products here. Within networking, lasers and dies used in optical interconnects grew 3X, PCI Express switches grew 2X and Broadcom is shipping 5nm 400GB NICs and 800GB DSPs.
- The CEO stated non-AI networking bottomed in Q2 and was up 17% QoQ yet down (-41%) YoY
- The CEO stated custom AI accelerators grew 3.5X year-over-year. Notably, we did not get a QoQ number which is where the weak metric was at $3.1B AI revenue flat QoQ.
Infrastructure solutions revenue was $5.80 billion, accelerating to 200% YoY growth from 175% YoY in the prior quarter. The segment was up 9.7% QoQ and this segment also grew QoQ last quarter, which helps to illustrate the acceleration from VMWare.
- VMWare contributed $3.8 billion with the acquisition helping to drive the strong YoY growth.
- VMWare’s annualized booking value (ABV) was up 32% QoQ to $2.5 billion, and is shaping up to be a major piece to Broadcom’s story. You can read more about this here. Two quarters ago, the ABV for VMWare was $1.2 billion, proving there has been a sudden acceleration underway. The VMWare segment is expected to be quite profitable, achieving adjusted EBITDA of $8.5 billion by next fiscal year. During the Q&A portion, it was discussed the overall software margin will remain between 80% and 90%.
Aligned with the commentary that the non-AI segments have bottomed (with the exception of Broadband), the remaining revenue segments reported QoQ growth despite being down double digits YoY.
- Server storage connectivity revenue was $861 million, up 5% QoQ yet down (-25%) YoY. Server storage is expected to grow QoQ yet will be down YoY
- Wireless revenue of $1.7 billion grew 1% YoY and is expected to grow 20% QoQ next quarter.
- Broadband revenue declined 49% YoY and is expected to bottom in the beginning of 2025.
On the call, an analyst asked if these segments will return to prior levels, to which the CEO stated they would and he cited bookings as an indication the bottom is likely behind them.
Hock Tan:
“As you all know, we've gone through your typical down cycle of semiconductors. And I'm referring particularly to non-AI, and we have talked about that before many times. We've gone through a down cycle as the ecosystem, as many of our customers, but the broad ecosystems, work on an adjustment in inventory levels in all stages in the supply chain. And we're not immune from it, obviously as we try to insulate ourselves from it as much as possible. We've gone through it. And the signs on the indications we have seen very clearly is we have, in fact, passed through the bottom. The best indicator is the bookings we are receiving. In non-AI, our bookings in Q3 of non-AI semiconductor demand is up 20%. And so that tells us we are well on the way to recovery.”
Margins
As outlined in our pre-earnings analysis, the VMWare merger integration has weighed on margins so far in fiscal 2024, though Q3 showed more positive signs on margin recoveries. Adjusted margins strengthened sequentially across the board, with larger growth visible down the line.
- Gross margin was 63.9% in Q3, down from 69.5% in the year ago quarter but up from 62.3% in Q2. Adjusted gross margin was 77.4%, up from 75.1% last year and 76.2% last quarter.
- Operating margin was 29.0% in Q3, up from 23.7% last quarter and a remarkable increase from 17.3% in Q1; however, Q3’s margin remained much lower on a YoY basis, down from 43.4% last year. Adjusted operating margin was 60.8%, up from 57.2% last quarter but decreasing from 62.4% last year.
- Net margin was (14.4%) for Q3, due to a one-time non-cash tax provision of $4.5 billion in the quarter. Adjusted net margin was 46.8%, up from 43.2% last quarter but down from 51.8% last year.
Regarding the tax liability, there was a question in the Q&A session if it was related to selling assets, to which the CFO responded that it was not due to a sale of assets, rather: “It's just we relocated the IP and that caused the $4 billion charge. The offset to that is a deferred tax liability. So think of that as noncash, very little cash impact to that.”
EPS
GAAP EPS was ($0.40), not comparable to estimates for $0.55 due to the $4.5 billion tax provision in the quarter. Adjusted EPS was $1.24, beating estimates by $0.04, and representing YoY growth of 18% and QoQ growth of nearly 13%.
Adjusted EPS growth is currently estimated to accelerate to nearly 24% YoY in Q4, and to the low-30% range for the first half of fiscal 2025. Given the sequential rebound in margins (partially due to better controlled costs at VMWare) and adjusted EPS beat in Q3, these growth projects may get revised higher in the coming days.
Q3’s adjusted EBITDA was 62.9%, with growth of 42% YoY to $8.22 billion. This was a solid improvement from 59.5% in Q2. Management guided for a 64% adjusted EBITDA margin in Q4, with the sequential improvement being driven by the integration of VMWare as Broadcom charts a path to pre-acquisition EBITDA margins.
Cash Flows and Balance Sheet
Cash flows and cash flow margins improved sequentially, while total debt took a step lower this quarter.
- Operating cash flow was $4.96 billion, increasing more than 5% YoY and 8% QoQ. Operating cash flow margin as 38.0%, improving from 36.7% last quarter, though this is lower than pre-acquisition margins of 53.2% in the year ago quarter.
- Free cash flow was $4.79 billion, rising more than 4% YoY and nearly 8% QoQ. Free cash flow margin was 36.7%, increasing from 35.6% last quarter but also lower than the 51.8% margin in the year ago quarter.
- Cash, equivalents and investments totaled $9.95 billion.
- Total debt was $69.96 billion at the end of Q3, down from $74.02 billion in Q2, with Broadcom repaying more than $9.2 billion of debt in the quarter, offset by nearly $5 billion in proceeds from long-term borrowings.
Valuation:
Broadcom is priced for perfection at 32 forward PE Ratio and 14 forward PS Ratio. We’ve covered semis since 2018 and a quality semiconductor stock rarely trades at these levels, it’s normally in the 6-8 forward PS range.
The 3-year median is only available on current PE Ratio, but I have a 3-year PE ratio of 28.5 compared to the current PE ratio of 65.8. The 5-year median is at 39.5.
Earnings Call:
Analysts asked in various ways what growth rate they could expect on AI revenue moving forward, but to no avail on any specific numbers. Here was the first question on the call:
Question
Vivek Arya (Analysts)
Just a clarification, Hock, and then the question. So I think AI revenue roughly $3.1-ish billion in Q3, flattish sequentially. What was the mix in terms of compute versus networking? And the $3.5 billion for Q4, what do you see of that mix? And then as we get into fiscal '25, I realize you're not guiding overall AI, but just how is your general kind of confidence and visibility? Do you think that Broadcom can kind of grow in line or better than the overall AI silicon industry in fiscal '25?
Answer
Kirsten Spears (Executives)
Yes. Well, as we indicated in the last earnings call, for this past quarter, I think we're talking about 2/3 in compute and 1/3 in networking. And we kind of expect Q4 to run the similar trend. And to answer your second part, no, we don't guide yet for fiscal '25, but we do expect fiscal '25 to continue to be strong, to show strong growth on our AI revenue.
-End Quote
There was a more tempered tone in terms of timing. For example, when asked where custom silicon is in the adoption curve, it was stated it will take some time.
Question
Edward Snyder (Analysts)
Right. That basically suggests that you're on the early part of your curve where I'm not trying to call the GPUs whatever, but you could be getting to something closer to the peak of the GPU market just because everything, right, beside the cost expense and as you're spending all this money and you're paying all this money for power, the ASICs become more and more attractive. So the curves are going to look different, right?
Answer
Hock Tan (Executives)
It's an accelerating curve. It may take longer than we all want it to happen but definitely accelerating because the size of the demand from those hyperscalers will totally rival that in the enterprise.
-End Quote
Conclusion:
Given AI growth has plateaued this quarter from its rapid growth, there will likely be a re-rating of Broadcom’s valuation sometime in the next 1-2 quarters. Our goal is to trim this position and buy back at lower levels. This strategy requires remaining steadfast to the bigger picture as this company is setting up to be a clear winner over the next decade. We want to do our best at actively managing the position while not losing sight of the bigger picture. With that said, valuation is a common pitfall for tech investors, who grow complacent with their positions. Our firm works to avoid valuation traps, and thus we plan to follow our disciplined process, which is to actively manage stocks that are richly valued.
Damien Robbins, I/O Fund Equity Analyst, contributed to this analysis
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