The narrative surrounding Broadcom Inc (NASDAQ:AVGO) certainly has changed in a hurry. AVGO stock had been one of the better performers even in a strong chip space; even with a recent pullback, Broadcom stock has risen 600%+ in the past five years. A steady diet of M&A and solid organic growth made AVGO one of the more widely praised stocks in all of tech.
But since the company’s takeover of Qualcomm, Inc. (NASDAQ:QCOM) was squashed last month, the sentiment surrounding Broadcom stock seems to have changed. AVGO stock has fallen 20% from late November highs, with a nearly 10% drop in just the last few sessions amid concerns about the semiconductor sector.
I’ve even seen AVGO called out as some kind of semiconductor version of Valeant Pharmaceuticals Intl Inc (NYSE:VRX), a roll-up doomed-to-fail company as its sector turns south.
From here, the selloff itself looks like an overreaction. While there seems to be some fear that Broadcom may look to make another big deal with its pursuit of Qualcomm denied, recent events suggest otherwise.
Broadcom has generated solid organic growth of late — its rise over the past few years hasn’t come from just M&A. And AVGO stock looks downright cheap at this point. With Broadcom stock near a support level, and offering a 3% yield, intrepid contrarian investors should at least take a long look at it.
A 20% Selloff in Broadcom Stock
What’s interesting about the recent decline in Broadcom stock is that it can’t be attributed to the Qualcomm deal falling apart. AVGO shares actually rose on the news that the deal had been called off. Certainly, some investors saw the deal, even at a higher price, as beneficial. But it’s not as if Broadcom stock was reliant on the Qualcomm deal to go through to have any sort of bull case.
Indeed, AVGO stock now trades about 6% below where it did before rumors of the deal started circulating. And that’s despite a pair of earnings beats since then and just a 2% decline in the SOX (Philadelphia Semiconductor Index).
It’s possible that investors are worried that Broadcom will simply go and make another deal — one which might not be as attractive as the Qualcomm acquisition looked (at least on paper; I think Qualcomm has a number of challenges).
M&A aside, there are real concerns surrounding the semiconductor space at the moment. A selloff in Apple Inc. (NASDAQ:AAPL) has led investors to remember that the industry is cyclical. Broadcom has exposure to the iPhone and more broadly to the apparently slowing smartphone space.
Given the amount of news surrounding AVGO stock, the uncertainty surrounding M&A, and sector weakness, investors have chosen to sell first and ask questions later.
The AVGO Story Is Wrong
But there are a number of reasons to see the selloff in AVGO as an opportunity. The roll-up concerns look badly overwrought. Broadcom does have some debt but only about $10 billion on a net basis, or well less than 2x EBITDA. Its organic growth actually has been solid and better than the industry as a whole, as analysts at Bernstein pointed out last year.
This isn’t a company creating growth solely through M&A, or using acquisitions to cover up declines in its legacy business. Rather, Broadcom’s M&A strategy has been targeted and successful. This is a $100-billion company whose share price has risen by a factor of seven over the past five years.
That alone should negate the fears about a value-destructive deal. An XLNX deal might make some sense, but with Xilinx’s market cap around $17 billion, it wouldn’t be enough to trip Broadcom’s growth story up. Meanwhile, Broadcom just announced a $12-billion repurchase authorization — enough to buy back over 12% of its shares at the current price.
That seems to signal that Broadcom now sees itself as too cheap, and that’s a relatively easy case to make.
An Opportunity in AVGO Stock
AVGO stock trades at just 11x forward EPS. The average analyst target price is $321 — an absolutely massive gap for a company this size. If the Street is right, Broadcom stock has 40% upside.
And if analysts are too optimistic, there’s still room for gains. Simply moving to a 14-15x multiple would get AVGO back to recent highs and suggest 25-30% upside. That’s not a huge ask for a growing company. Intel Corporation (NASDAQ:INTC) trades at 13.4x with relatively tepid growth and substantial exposure to the declining PC space.
The recent trading in AVGO really looks like a market that is unsure and is selling off the stock based on sector weakness. But there aren’t real catalysts here, though a cyclical downturn in the semiconductor space is a real risk.
But at 11x forward EPS, AVGO is pricing in a reasonably high probability of near-term weakness. Worrying about the M&A strategy of a company who has made solid acquisition after solid acquisition makes little sense. Debt is not a significant issue.
The 20% selloff in Broadcom stock simply has been too much. And it creates an opportunity for investors willing to step in.
As of this writing, Vince Martin has no positions in any securities mentioned.