Broadcom Corporation (BRCM): Trends that Give It A Buy Rating

Going forward,  I believe the industry dynamics are expected to change, with several companies willing to outsource manufacturing in order to reduce the fixed cost and overall CAPEX.

Texas Instrument owns most of its production facilities, which implies a high level of operating leverage–thus any reduction in demand can negatively affect the company’s profit.  Moving ahead, this may put pressure on Texas Instruments Incorporated (NASDAQ:TXN), as competitors that outsource manufacturing have a higher level of flexibility in product pricing and therefore can address the falling demand accordingly, unlike Texas Instruments Incorporated (NASDAQ:TXN).

As previously mentioned, Broadcom also competes with QUALCOMM, Inc. (NASDAQ:QCOM). Qualcomm generates the highest percentage of its revenue through mobile-device chipsets, at around 64%. This is followed by mobile-device royalties at around 30%. According to the projections offered by Trefis, Qualcomm’s free cash flow for the year 2013 is expected at around 43% of its total gross profit.

During 2012, QUALCOMM, Inc. (NASDAQ:QCOM)’s market share in the chipsets category stood at 65%  It plans to bolster its 3G business by expanding in India and China. However, it now faces an increasing threat from Broadcom’s growing presence in this category.

Stock price has 15%-to-25% upside potential

Broadcom Corporation (NASDAQ:BRCM) is gaining huge momentum in the set- top box business, as it reported a 15% increase in shipments during fiscal 2012.

The outlook is highly favorable, as demand for technologically advanced set-top boxes from developed countries is only expected to grow. Further, the shift to digital platforms in emerging markets should also add to the overall growth.

As per my estimate, the wireless and connectivity division, which is the most valued business category for Broadcom, is expected to report consistent growth for the next five years. According the valuation offered by Trefis, the free cash flow generated through this division will stand at around $600 million during 2013.

Using the DCF model, my conservative target price for Broadcom’s stock should be around $38.15 (15% upside); however, a more bullish view on its stock gives us a target price of $41.43 (25%). This bullish view implies more-than-expected growth in all business categories.

Ashit Gulati has no position in any stocks mentioned. The Motley Fool owns shares of QUALCOMM, Inc. (NASDAQ:QCOM).