Despite a slowing growth rate, chip giant Broadcom (NASDAQ:AVGO) has managed to outperform most of its peers in the semiconductor industry. The company reported a 5% year-over-year increase in revenue to $8.88 billion for the fiscal third quarter of 2023, ending in July. This is, however, a deceleration from the 8% growth witnessed in the second quarter and the 16% growth in the first quarter.
Broadcom's impressive performance comes amid a general slump in the semiconductor industry that began late last year due to an oversupply of chips for PCs and smartphones. The downturn has since expanded to cloud computing chips, particularly non-AI cloud chips.
Despite the industry-wide downturn, Broadcom's earnings per share (EPS) and free cash flow (FCF) rose 8% and 7%, respectively, compared to last year. FCF profit margins also rose, reaching nearly 52% during the quarter.
The standout segment for Broadcom in Q3 was networking, which reported a 20% year-on-year growth at $2.8 billion. This is where Broadcom reports revenue from its AI networking chips, including the Tomahawk 5 switching chip and the Jericho3-AI router. Excluding AI networking, Broadcom's semiconductor business remained flat year-over-year.
Looking ahead, Broadcom has received regulatory approval for its pending merger with cloud computing infrastructure company VMware (NYSE:NYSE:VMW) in all jurisdictions except China. The merger is expected to be completed by October 30, marking the end of Broadcom's 2023 fiscal year.
The acquisition is set to transform Broadcom's focus between chip design and software development. Over the past year, VMware sales were $13.6 billion, up just 3.6%, but free cash flow rose by 47% to $4.66 billion, an FCF profit margin of 34%. Broadcom hopes to enhance this cash generation by integrating VMware into its existing infrastructure software business, which was also built by acquisitions over the past decade.
Currently valued at a market cap of nearly $71 billion, the deal will be paid for in approximately half Broadcom stock, half cash. Based on this valuation, Broadcom is purchasing VMware for about 16 times free cash flow. CEO Hock Tan is confident that this acquisition will further boost FCF profit margins to 50% and beyond.
While Broadcom's stock was notably cheap late in 2022 and into early 2023, its value has since increased. However, with a current price at 21 times trailing 12-month free cash flow, it is not considered overly expensive. The company has been a strong dividend growth story and has supplemented shareholder returns with ample stock repurchases. The same strategy is expected to continue once the VMware merger is completed.
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