With Thursday’s agreement by Avago Technologies Limited (NASDAQ:AVGO) to buy Broadcom Corp. (NASDAQ:BRCM) for a whopping $37 billion — the largest merger of chipmakers on record — mergers and acquisitions seem to be the new growth strategy among the semiconductor sector.
And it’s one that’s likely to boost the long-term value of AVGO stock.
Why? For companies like Singapore-based AVGO that are looking to diversify into new businesses, buying a smaller player or merging with a rival makes plenty of sense. After all, companies with tons on cash and little growth can only spend so much buying back their own stock. They can’t survive by grossly underinvesting in themselves.
AVGO has no plans of being in that category.
The merger of Avago and Broadcom, which have combined 2014 sales of $12.7 billion, will create the world’s No. 3 chipmaker by revenue, trailing only Intel Corporation (NASDAQ:INTC) and Qualcomm Incorporated (NASDAQ:QCOM).
But unlike Intel, Avago has the benefit of being an important parts supplier to Apple Inc (NASDAQ:AAPL). The iPhone maker accounts for more than 10% of AVGO’s annual revenue.
So, when the Avago/Broadcom deal is signed, sealed and delivered, investors can expect a domino effect of more deals — whether of similar sizes or larger to unfold. Investors should pay particular attention to Intel, which desperately want to make a splash with strategic deal, especially given Broadcom’s advances in the Internet-of-Things.
Likewise, Qualcomm is a name not to sleep on. With activist investors circling its headquarters, QCOM may be hungry to respond with its own deal. And don’t be surprised QCOM steps in for Avago if the Avago/Broadcom deal hits a snag. Qualcomm could desperately use some life on its top line.
On Thursday, AVGO reported earnings of $2.13 per share, topping last year’s mark of 85 cents for an increase of 151%. Aside from the strong year-over-year surge, AVGO beat the analysts’ estimates by 12 cents. Revenue soared 135% year over year to $1.64 billion, also topping Street revenue estimates of $1.63 billion.
It should be no surprise AVGO is dominating both revenue and profits. Consumers love their mobile devices and are always looking for the newer model with better features. And Avago’s chips are are the center of the iPhone 6 and 6 Plus models that Apple — seemingly — can’t make enough of.
Because of the great demand for Apple’s iPhones and what it would mean for AVGO, the average earnings estimate by analysts had been raised three times, from $1.98 per share to $2.01. That AVGO still beat results by 12 cents imply that analysts can’t keep up with the company’s growth.
And this explains why AVGO stock, which closed Thursday at $142.38, is merely 1.5% away from its analysts’ average price target of $144.50. Even when factoring out the boost AVGO may get by engulfing BRCM, AVGO stock can still deliver 25% to 30% more gains in the next 12 to 18 months, reaching levels of $180 per share.
The synergies with BRCM and Avago’s ability to scale in high-margin foundry areas are likely underestimated.
As of this writing, Richard Saintvilus did not hold a position in any of the aforementioned securities.
