Broadcom Review: Apple Customer Risk

Summary:

• Broadcom faces significant risks from Apple’s potential move to in-house chip production and increased US controls on AI chip exports.
• Despite a solid Q4 performance, Broadcom’s reliance on Apple for 20% of its revenue poses a substantial threat to its business model.
• AVGO’s current valuation is unjustifiably high given the looming risks, with a forward P/E ratio significantly above the sector median.
• The market’s bullish outlook on AI chip demand is overshadowed by broader business risks, making Broadcom a strong sell.

Co-Authored by Noah Cox and Brock Heilig

Investment Thesis

Broadcom (NASDAQ:AVGO) (NEOE:AVGO:CA) shares have outpaced the market since the last time I wrote on the custom chip company, with all of the outperformance occurring as a result of their earnings report. Shares are up roughly 26.67% but are trailing the S&P 500 by 3.75% since my last research piece on October 30.

On Thursday, Broadcom reported earnings that largely beat expectations, with the exception of their Q4 revenue. Although earnings came in stronger than expected, the company’s risks related to both China and its key customer Apple are actually continuing to pile up. I think the devil is in the details on this one. My goal with this coverage is to provide a counterpoint to the overall bullishness from the analyst community since the earnings call last night.

On Wednesday afternoon, news broke that major Broadcom customer Apple (AAPL) will potentially be phasing out Broadcom from its future mobile chip plans for both its WiFi and Bluetooth technology. This could start as soon as next year with certain HomePod and Apple TV technology. While similar news broke over the last few days that Apple wants to work with Broadcom on its own AI chip, this AI chip would be for servers and not for devices the tech giant sells. I am not sure these would net out to a wash (Broadcom will likely lose net revenue from the result of these two announcements).

Adding to this, news broke last week that the US is looking to put harsher controls on AI chip exports from US companies (including Broadcom). Broadcom pointed to custom AI chip growth as a big source of demand going forward on the call last night. Broadcom gets 32% of its revenue from China. It gets 20% of its revenue from Apple.

With this risk, I don’t see a lot of upside in Broadcom at all. Frankly, I continue to see downside in shares. While controversial, I continue to believe shares are a strong sell.

Why I’m Doing Follow-Up Coverage

While Broadcom shares are up since the last time I covered the chip company, I still don’t think the market is pricing in the risks from China and now Apple. The market seems too focused on the custom AI chip demand, which could have a SAM of $60 to $90 billion/year in just a few years. While the company proclaims this will be a big opportunity, I think we have to net this against the risks. This does not appear to be happening based on the market’s movements.

The reason I am concerned that the market is over indexing on AI chip demand is because it ignores two real risks that impact revenue the company earns today. Investors are banking their hopes on guidance for 2 years from now, yet ignore concerns about Apple revenue today, and the risk of AI chip restrictions in China.

I think there is a real risk that Broadcom could face from its Chinese operations, and now also from a unique competition risk in Apple. Apple is looking to move in-house its chip production, working with a Taiwan Semiconductor.

The purpose of me doing this follow-up coverage is to do a deep dive on the core fundamentals and outlook on the company, especially when the market is so bullish (as seen with the price movement last week). While the stock has moved up a ton since the last time I wrote on the chip giant, I actually think the fundamentals have gotten net worst over the last few months, not better.

Q4 Review & Apple Risk

While I am overall bearish on Broadcom, I will admit the company did an overall solid job of meeting expectations for the most recent quarter. Broadcom finished FY Q4 with a Non-GAAP EPS of $1.42, which outperformed the projection of $1.39 by $0.03.

And in terms of revenue, Broadcom was a little light compared to what expectations were. With a 51.2% year-over-year increase in overall revenue, Broadcom finished slightly below estimates at $14.06 billion in revenue for the quarter. Estimates were for roughly $14.10 billion.

For FY 2025 Q1 guidance, Broadcom is on pace to bring in $14.6 billion, which, if met, would be a 22% increase from the year prior period. Adjusted EBITDA guidance for Q1 2025 is expected to be roughly 66% of estimated revenue.

Broadcom President and CEO Hock Tan summarized their Q4 growth on their December 12th earnings call.

Semiconductor revenue of $8.2 billion grew 12% year-on-year and 13% sequentially. Q4 AI revenue grew a strong 150% year-on-year to $3.7 billion. Non-AI semiconductor revenue declined by 23% year-on-year to $4.5 billion, but still a 10% recovery from the bottom of six months ago.

While I will admit that revenue growth was strong, the reason I am discounting this strong growth is because Broadcom did not address concerns about Chinese chip export restrictions on their conference call. In fact, the company did not even mention China once. There is real downside risk.

Tan did address Apple, which he refers to as Broadcom’s ‘North American’ customer. Apple accounts for a good portion of Broadcom’s overall revenue, so it’s important to pay attention to what Tan says about Apple during the earnings call.

Turning to wireless, as we expected, seasonal launch by our North American customer drove Q4 wireless revenue to $2.2 billion, up 30% sequentially. This was up 7% year-on-year because of higher content. We continue to be very engaged with this customer in multi-year roadmaps across various technologies we have leadership in, including RF, WiFi, Bluetooth, sensing, and touch. In Q1, reflecting seasonality, we expect wireless to be down sequentially, but still be flat year-on-year.

According to reports, Apple is looking to drop Broadcom as a chip provider and move to an in-house chip for Bluetooth and wireless connections starting as early as next year. The in-house chip, which is nicknamed Proxima, will be produced overseas by the Taiwan Semiconductor (TSM). The nuances are in the details here. Broadcom (according to reports) could lose Apple’s business in phases. So the report, and the earnings call commentary, can be true at the same time. Apple can be cutting back orders while still planning some orders for the next couple of years. This does not mean Apple revenue is sustainable.

As I mentioned before, Apple accounts for roughly 20% of Broadcom’s total revenue in the fiscal years 2023 and 2022.

Based on my math, I believe Apple has accounted for about $7 billion of Broadcom’s revenue in each of the last two fiscal years, totaling about $14 billion over the two-year span.

This clearly would pose a big problem for Broadcom and its business model. Potentially losing out on 20% of yearly revenue is obviously not a promising outcome as it relates to the future of the Broadcom company. If Apple ultimately does decide to cut off Broadcom, the company would then need to scramble to find other customers in an effort to regain that lost 20% of revenue, which as I stated previously, would be roughly $7 billion per year.

As an offset to this, Apple is reportedly looking to team up with Broadcom in another area. The two companies are in talks of putting together an AI server chip to help power some of Apple’s new key AI services. This could obviously be beneficial for Broadcom, but I do not think it will be nearly as big of a revenue benefit as the wireless Bluetooth chips that Broadcom has been selling to Apple.

In my opinion, when we look at the net loss, we need to look at the expected outcomes of each.

For the loss of WiFi and Bluetooth chips, Apple has been signaling since early 2023 (according to Bloomberg) that this would occur. The consistency tells me this is going to happen (and not a one-off rumor).

On the AI GPU side, while there is little data available, it’s clear that Apple is going through with a strategy of outsourcing deep AI models to companies such as OpenAI by partnering with them. On their own, Apple used 8,192 of Google’s Tensor Process Unit (TPU) chips. If we assume that Apple buys approximately 10,000 of their own custom GPUs per year from Broadcom for a similar level of training, at a sale price of roughly $40,000 per GPU, this would mean roughly $400 million annually to Broadcom.

In essence, Broadcom is likely going to lose $7 billion a year in wireless and Bluetooth chip business in exchange for $400 million in AI GPU business. This is a net loss of $6.6 billion in annual revenue.

Although I’m skeptical on business with Apple, the AI chip industry overall is massive. CNBC reports that Tan said the AI chip market opportunity could be worth anywhere from $60 billion to $90 billion per year by FY 2027. This needs to be offset against losses, however. This is my major concern.

Valuation

With up to 20% of Broadcom current revenue at risk, I think the stock is extremely expensive on a forward GAAP price-to-earnings basis. The company currently has a P/E ratio of 46.75, which is a steep 47.96% higher than the sector median of just 31.60. Seeking Alpha gives Broadcom a grade of a C- on this valuation metric.

The company also trades at a hefty premium to the forward price-to-sales ratio as well. With the sector median being just 3.29, Broadcom currently has a price-to-sales ratio of 13.91, meaning that Broadcom’s ratio is at a 322.38% premium to the sector median. Broadcom earns a grade of a D- on this metric, according to Seeking Alpha.

Assuming Broadcom has a real issue with Apple WiFi and Bluetooth chips that could soon result in Broadcom losing 20% of its overall revenue, that’s a huge deal. The company shouldn’t be trading at such a premium to the sector median in this case. While some bulls may believe that Broadcom should trade at such a premium to the sector median, I disagree. The company is trading at a premium as if growth will be strong (and without bumps) from here going forward. Between export risks to Chinese customers and waning Apple demand, I am not as optimistic.

Personally, I think Broadcom should be trading much closer to the sector median forward price-to-earnings ratio until investors have clarity on where Apple revenues will go from here. This is on top of China revenues, which, I think, are unpredictable from here.

If we saw shares trade at the sector median forward price-to-earnings ratio of 31.60, down from 46.75, this would represent 32.40% downside for the company.

Bull Thesis

The biggest bull thesis for Broadcom is that relations between the US and China get better, and also that Apple’s new AI chip turns out to be a fruitful endeavor.

Unfortunately, I think Broadcom is going to have a tough time creating a net benefit for shareholders with Apple’s switch from Broadcom’s wireless Bluetooth chip netted against their new AI chip.

While former President and President-elect Donald Trump has invited Chinese leader Xi Jinping to his inauguration on January 20, this is not a surefire indicator that relations between the US and China will get better. If anything, Chinese President Xi Jinping has declined the invite. Investors had been hoping that President-elect Trump could help thaw relations with China. The invitation rebuff is not a positive signal.

This comes as the US prepares more AI chip restrictions.

Specifically, these chip restrictions (which are all but certain to take effect because the Commerce Department has been working on them since October of 2022) would put a cap on the number of AI chips that can be exported to China.

Directly, this would impact Broadcom because many of their new AI chip projects run through Chinese-based companies (like ByteDance/TikTok). I talked about this in my previous research from October.

In essence, I see it as a high likelihood that these regulations impact Broadcom. I’m just not sure how a company with 32% of its revenue from China reacts quickly to this.

While Broadcom is spoken extensively about custom AI GPU demand driving $60-90 billion in FY 2027, these are guidance assumptions (with huge variance). There is no guarantee this will come to fruition.

Again, as I mentioned before, investors are paying a premium PE for a company that is losing real customers today (to both competition risk and regulatory risks). In exchange, they are picking up the assumption of more revenue in the future as a part of a diversification strategy.

There is no guarantee this will work. The stock is priced like this is going to happen. There appears to be a mismatch.

Takeaway

Broadcom trades at an expensive premium to the sector median forward price to earnings ratio. Yet, I don’t believe the company has enough going for it (especially with the risks related to Apple) to warrant this valuation premium.

While shares rallied this week, the company is in a precarious position. Apple is reportedly looking to move in-house for its chip production, which would effectively cut off Broadcom as a supplier to Apple for mobile chips. Some of this would be netted against rumored AI server chips, but this will likely net to a net loss in revenue for the custom chip giant.

While the street is optimistic about AI, I think we need to look at the rest of their business to get the bigger picture. With this, I continue to believe shares are a strong sell.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of TSM either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Noah Cox (main account author) is the managing partner of Noah’s Arc Capital Management. His views in this article are not necessarily reflective of the firms. Nothing contained in this note is intended as investment advice. It is solely for informational purposes. Invest at your own risk.

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