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A Few Reasons Why This Stock Was Unfairly Punished

Harsh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

One of the most frustrating experiences in life can be when, as an investor, you see your investment go under. The frustration multiples when the company that you’d invested in had good prospects, solid clients, and great innovation; but still, it fails to do well as an investment.

A similar thought would be running through the minds of Broadcom (NASDAQ: BRCM) investors, the semiconductor company which, according to me, is among the best bets to benefit from the proliferation of data going forward. However, the stock and the company haven’t moved in tandem and the market has probably underplayed the potential of Broadcom so far.

Unfairly done?

So, when the company issued a downbeat guidance when it reported its recently released second-quarter results, it wasn’t surprising to see Broadcom shares getting beaten up badly. The stock had held its own this year before the earnings report, even though the Street hadn’t been rewarding its estimate topping results over the past few quarters. But one misstep and the bears were out in full force, and the stock is presently languishing near its 52-week low.

I agree that Broadcom missed on the top line by a whisker, and that its outlook wasn’t too great with the company guiding for revenue of $2.05 billion to $2.20 billion, below the estimate of $2.25 billion. However, what contributed to the massive fall in share price and the company’s woes since earnings were reported in late July were fears regarding its position in baseband chips. Slow sales of 3G baseband chips sent analysts on a downgrade spree and Broadcom has been struggling ever since.

But, did analysts miss certain important points? While a downbeat guidance is certainly a concern, should one annihilate Broadcom’s long-term credibility without going into the specifics? Certainly not! Management stated that weakness in 3G chips was a result of overstocking by its customers, along with some decline in demand.

Broadcom has one major customer for its 3G baseband chips according to management, and they accept that they don’t have many customers in this area now, but what analysts failed to highlight was the fact that Broadcom recently introduced a quad core chip which will begin shipping in the ongoing quarter.

Also, the company expects to find a place in more phones in the second half of the year. In addition, when you consider that Broadcom hasn’t stepped into the LTE baseband market yet, it doesn’t make much sense to chastise the company over witnessing weakness in 3G. Moreover, it looks like everyone forgot that Broadcom did deliver a 7% growth in its Mobile & Wireless segment, clocking $967 million.

Missing the point

Coming to the guidance, the fact that Broadcom derives a third of its revenue (according to Los Angeles Times) by supplying chips to Apple (NASDAQ: AAPL) and Samsung (NASDAQOTH: SSNLF) might have played a part. The fact that Samsung hasn’t been able to sell as many units of the Galaxy S4 as it would have liked led the company to slash orders for components, and this might be one strong reason why Broadcom guided below expectations.

So, Samsung’s over-enthusiasm was also probably a reason why Broadcom had to suffer. As Reuters reports, analysts have slashed sales projections of the S4 by a staggering 30% in recent times, and the upcoming release of the next iPhone would probably dent sales further. But, you cannot force Broadcom to sell more chips to Samsung when the Korean giant doesn’t want it because it has produced too much already.

Going forward, Broadcom is looking at a sequential increase in mobile revenue, as against a decline of 3% (sequentially) in the previous quarter. While an iPhone refresh might hurt Samsung, it would benefit Broadcom since the company has been a long-time fixture in the iUniverse and it would look to maintain its position this time as well after being in the iPhone 5.

Why ignore the good?

The production of the next iPhone is well underway as we near launch date, while the clamor for a cheaper iPhone is also getting stronger by the day with various leaks indicating that such a product might exist after all. So, it’s clear that analysts are missing the point that if a cheaper iteration of the iPhone indeed exists, it might help Apple spread its wings in the emerging markets and also augment Broadcom’s addressable market.

So, it’s not all doom and gloom for Broadcom, and it should also be noted that the company also supplies its chips for the iPads. Moreover, Broadcom’s potential with its cutting-edge NFC chips and 5G Wi-Fi chips, which grew 50% on a sequential basis in the previous quarter, should not be ignored. In addition, the company is focused on diversifying its mobile customer base further. It was recently selected by ZTE to supply small cell baseband processors for its residential access points.

It is small things like these that we shouldn’t miss, as the world is becoming a more connected place by the day and Broadcom’s products should be in great demand since its chips enable connectivity. Too much has probably been made of the company’s weak performance in 3G baseband, but no emphasis has been laid on 4G efforts.

Don’t be blinded

Moreover, Broadcom is a pretty small player in baseband processors, occupying just 5% according to Strategy Analytics. So, a relatively weak performance in that sector shouldn’t have led to such a massive sell-off. So now, it looks that weakness at Samsung might be one of the reasons why Broadcom issued a soft outlook. Simply said, it’s a short-term problem, as smartphones are still going to grow at an annual rate of almost 19% till 2016, according to IDC, and Broadcom’s products have a lot of room for growth still.

Connected homes, Internet of Things, and even connected cars could be some of the drivers that we are ignoring right now. And the thing which irked me the most when analysts were analyzing Broadcom’s quarter was that the Broadband Communications and the Infrastructure & Networking businesses, which together accounted for more than $1 billion in revenue weren’t discussed at length, while its small 3G misstep garnered so much attention.

Stay tuned

These other two businesses have been performing very strongly, and I would focus on them in my next post. However, for now, one thing is pretty much clear -- Broadcom’s mobile weakness seems overblown and the company should recover once the short-term headwinds clear off.

Check back this space for more reasons why Broadcom is still a good stock to hold and why investors should consider scooping up more shares at these depressed levels with the stock trading at a forward P/E of just under 10 times.

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Harsh Chauhan has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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