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### Unleashing Record-Breaking AI Potential: Broadcom’s Software Evolution

Generative AI is already powering growth in Broadcom’s semiconductor business, while the recently c…

Following the recent completion of the \(61 billion takeover of cloud-software giant VMware, investors lauded the semiconductor company’s enhanced revenue diversification, with shares of Broadcom (AVGO) soaring to a new all-time high of \)1,284 this week, anticipating fresh growth prospects in AI.

Moving forward, there will be a stronger focus on high-margin network technology. Concurrently, Broadcom’s substantial networking sector, representing 30% of the fiscal 2023 (October) revenue, is poised to remain a key driver of growth. Additionally, Broadcom has presence in mobile chips, client storage, and broadband.

In the fiscal year ‘23, Broadcom garnered a total software revenue of \(7.6 billion, constituting 21% of the total revenue. The acquisitions of CA, Symantec, and Brocade have bolstered Broadcom’s software portfolio. Projections indicate that the total revenue for fiscal year ’24 is estimated to reach \)50 billion, with software revenue amounting to \(20 billion, comprising 40% of the overall revenue. Notably, VMware is expected to contribute \)12 billion to the software segment’s revenue in fiscal year ‘24, subsequent to spinning off two VMware units generating approximately $2 billion in revenue collectively.

Broadcom anticipates a comprehensive integration of VMware within a year, with potential integration costs up to $1 billion. Broadcom plans to realign VMware’s core business, focusing on developing personalized and cross-cloud environments for large enterprises. CEO Hock Tan highlights VMware’s advanced technology in virtualizing entire data centers beyond just computing functions, enabling the creation of on-premises private clouds for clients.

By leveraging VMware’s Cloud Foundation program, businesses can seamlessly run applications across diverse data centers and public clouds. Tan emphasizes that VMware excels in driving cost efficiencies, particularly on the hardware front, by managing workloads under a unified abstraction layer across various hardware platforms. Broadcom aims to invest in a comprehensive suite of service tools to optimize workload utilization.

As part of the VMware integration, Broadcom is transitioning its product to a subscription model, discontinuing new perpetual license sales and support renewals. While over 60% of VMware users currently possess perpetual licenses, customers with active support contracts can retain their perpetual licenses. Broadcom is collaborating with clients to facilitate the transition from perpetual licenses to the new subscription services.

Implementing these strategic shifts may pose challenges, potentially leading some clients to explore alternative vendors. However, Broadcom remains optimistic that the transition to subscriptions will be smooth given VMware’s established presence in numerous large enterprises and its continuous innovation across product offerings.

VM has intensified its technological initiatives to promote the adoption of relational AI, collaborating with Intel to aid businesses in developing AI designs and enhancing AI efficiency. Additionally, partnerships with IBM’s Red Hat aim to accelerate the deployment of AI functions.

Broadcom’s semiconductor segment is experiencing growth driven by generative AI. Network revenue surged by 23% to $3.1 billion in the October quarter, primarily fueled by heightened demand from hyperscalers for Broadcom’s specialized AI solutions, including social switches, routers, and network interfaces tailored for expanding AI data centers. Hyperscalers are increasingly deploying Ethernet, the standard protocol in front-end sites, within their AI networks.

Networking revenue for Broadcom climbed by 21% to $10.8 billion in fiscal year ‘23. With the expanding deployment of network connectivity and rising demand for AI capabilities from hyperscalers, the company foresees a robust acceleration in networking growth in the current fiscal year, potentially reaching 30%.

After doubling in 2023, Broadcom’s stock has risen by 10% in 2024. Previously trading around \(1,230, it now hovers just below several optimistic Wall Street price targets due to its strong performance. For instance, Truist recently raised its Broadcom target from \)1,015 to $1,240 based on a positive outlook for the Virtualization company and its newfound AI exposure.

In December, BofA highlighted Broadcom’s significant AI opportunities, raising its target from \(1,200 to \)1,250. Bernstein also increased its target earlier this month from \(1,150 to \)1,250, impressed by Broadcom’s growth strategy at VMware while effectively managing costs. Mizuho, with a target of \(1,250, acknowledges Broadcom’s industry-leading margins and free cash flow. In fiscal year ’23, the company generated impressive free cash flow of \)17.6 billion, reflecting a solid 49% ratio.

Goldman Sachs recently reinstated coverage on Broadcom with a “Buy” rating and a price target of $1,325. The firm is optimistic about Broadcom’s AI-related ventures, expects synergies from VMware to drive operating margin expansion and earnings growth, and anticipates a cyclical recovery in the traditional semiconductor business.

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Last modified: January 26, 2024
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