Broadcom Inc. (Broadcom) is a leading designer, developer, manufacturer and global supplier of a variety of semiconductor and infrastructure software products. The company is perfectly positioned to benefit from the current AI revolution, with its portfolio of products optimized for AI. While there is still significant demand for AI-optimized hardware products, it is clear that the triple-digit growth rates of previous periods are not sustainable, with Nvidia CEO Jensen Huang predicting 79.3% year-over-year revenue growth for the third quarter of 2025 had eyes. While a slowdown in growth is expected in the broader industry, Broadcom continues to show accelerating growth in its AI revenues, maintaining the strong pace throughout the third quarter. The recent integration with VMware has also strengthened the company’s AI-related enterprise software and cybersecurity capabilities, driving growth in the infrastructure software segment. However, non-AI revenue continues to hold back Broadcom’s overall performance as sales in those areas remain relatively sluggish. Despite this, Broadcom CEO Hock Tan stated during the earnings call that the slowdown in non-AI revenues has now bottomed out.
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Broadcom shares fell 10% after the earnings release (it has since recovered those lost profits), even as the company reported better-than-expected third-quarter results. Revenue rose 47% year over year, largely thanks to the AI boom and VMware’s contribution. Still, this positive report coincided with weak macroeconomic data, especially in a week marked by poor labor market data. This led to panic among investors and thus to a sell-off.
Broadcom has a large exposure to non-AI revenues, which are more cyclical and sensitive to macroeconomic dynamics. This cyclicality and sensitivity to macroeconomic pressures could also have amplified the effects of the sell-off. Nevertheless, I view Broadcom as a buying opportunity. The company continues to maintain high gross margins and generate significant free cash flow. In my view, the most compelling aspect of the recent earnings was the progress in VMware integration, which was in line with Hock Tan’s guidance and reflects its successful history of strategic acquisitions.
Broadcom’s revenue growth continues to be driven by the VMware acquisition. In the third quarter of FY24, the company outperformed both revenue and non-GAAP earnings per share expectations, with the Infrastructure Software segment posting an impressive 200% year-over-year growth, compared to 175% in the previous quarter. However, this comparison of year-over-year growth is not directly comparable because VMware’s revenue was not included in last year’s results. During the earnings call, management noted that VMware generated $3.8 billion in revenue this quarter, with quarter-over-quarter growth accelerating to 40.7%, compared to 28.6% in the second quarter.
VMware Cloud Foundation (VCF) was a standout, with an annualized booking value of $2.5 billion in the third quarter, reflecting a 32% quarter-over-quarter increase. On the other hand, Broadcom’s core software business, with the exception of VMware, experienced significant QoQ slowdown. While the company’s total revenue grew 47.3% year-on-year in Q3 FY24, non-VMware core business growth was just 4% year-on-year, compared to 4.9% growth in Q3 FY24. FY23. Management acknowledged the slowdown but was quite optimistic about the prospects, stating that non-VMware software revenue has now stabilized and is expected to grow in the mid-single digits going forward.
Broadcom’s Semiconductor Solutions segment continues to face challenges. After showing initial signs of recovery in the second quarter, the segment’s third-quarter revenue fell 4.8% year-over-year to a total of $7.3 billion. However, AI-driven demand from hyperscalers for Broadcom’s networking and custom AI chip products was a bright spot, with the networking product segment growing 43% year over year. Despite this strength, the rest of the Semiconductor Solutions segment – particularly non-AI networking, server storage and wireless products – underperformed, with relatively flat growth. According to management’s outlook, this weakness is expected to continue in the coming quarters. Nevertheless, CEO Hock Tan emphasized several times during the earnings call that the slowdown in non-AI revenues has likely bottomed out.
One of Broadcom’s key strengths lies in its margin performance, especially after the VMware integration. In the third quarter, the company posted gross margins of $8.4 billion, representing 36% year-over-year growth. Gross margin percentage increased to 64% from 62% in the previous quarter, driven by strong demand for AI-related products. GAAP operating margins also increased to 32.4%. The Infrastructure Solutions segment saw a sequential margin improvement of 700 basis points, while Semiconductor Solutions margins improved 80 basis points. Non-GAAP gross margins, which take into account amortized intangibles and other costs, reached 77%, up from 75% a year ago. These growing margins are also one of the main reasons for my bullish view on Broadcom at current price levels.
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In addition to strong margin performance, Broadcom’s free cash flow generation is another reason for my bullish view. The company generated $4.8 billion in free cash flow in the third quarter, up 4% year over year with a robust free cash flow margin of 37%, up 1 percentage point quarter over quarter. This strong cash flow generation, in my view, offsets any material risks for Broadcom and gives the company the flexibility to return more value to shareholders through dividends or share buybacks.
Broadcom ended the third quarter with $10 billion in cash and $72 billion in debt, racking up annual interest expenses of about $4 billion. Given management’s estimates for fourth-quarter EBITDA margins of 64%, I estimate Broadcom’s leverage ratio on an adjusted basis to be around 2.3x, which is a relatively safe level. It’s worth noting that credit rating agencies have recognized Broadcom’s solid capital structure, with Fitch upgrading its credit rating in August and S&P doing so in November 2023, following its acquisition of VMware.
Broadcom’s AI-related revenues continue to grow, with the company reporting $3.1 billion in AI revenue for the third quarter of FY24 and heading toward $3.5 billion for the fourth quarter of FY24. However, the full-year AI revenue forecast of $12 billion – up from the previous expectation of $11 billion – fell short of market expectations, raising concerns about a possible normalization of growth in the next fiscal year. This cautious outlook is reminiscent of Nvidia’s recent earnings figures, which also indicated subdued growth expectations in the AI sector. Despite these concerns, I believe the AI investment theme remains strong as technology companies continue to upgrade their infrastructure to stay competitive.
Management has expressed optimism about Broadcom’s non-AI revenue stabilization, pointing to a 20% year-over-year increase in non-AI bookings. This growth, along with management’s expectation that the cyclical downturn in non-AI revenues has “passed the bottom,” should give investors some more confidence in the company’s future. As the company navigates changing market expectations around AI revenues, I believe Broadcom’s competitive advantages – especially in networking solutions – will continue to drive its success in the AI space, while non-AI segments will gradually expand restore.
Broadcom’s current valuation appears more attractive than it did a few months ago, when enthusiasm for AI hardware makers like NVIDIA and AMD was at its peak. With management’s upgraded fourth-quarter forecasts, Broadcom is on track to deliver revenue growth of approximately 44%, bringing total revenue for the year to approximately $52 billion. This strong performance, along with the potential for further margin expansion following solid third-quarter results, suggests that a price-to-earnings ratio above 35x is justified.
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Currently, Broadcom is trading at a price-to-earnings ratio of around 29x, which represents a discount compared to its AI-focused peers, which are trading relatively higher in the 30x-35x range. Given Broadcom’s exposure to the AI market, its ability to generate consistent free cash flow, and its annual gross margin expansion, I think a price-to-earnings ratio of 33x is achievable. In this scenario, the stock would be valued at around $205 per share, implying around 15% upside potential.
Source: Alpha Spread
Looking at the valuation from a DCF perspective, based on Wall Street estimates, the model points to an even greater upside of around 25%, with an intrinsic value of $240 per share. This DCF model assumes a discount rate of 8% and a terminal growth of 3% after the forecast period. It also factors in strong revenue growth, with sales expected to increase from $60 billion in year 1 to $136 billion in year 5. In addition, net margins are expected to grow from 41% in year 1 to 503% by the end of this year year. the forecast period. While these assumptions are optimistic, they effectively reflect the significant upside potential for Broadcom at current valuation levels.
I highly recommend considering Broadcom, as the company has consistently demonstrated the ability to grow both revenue and profits. Despite a price-to-earnings ratio of 29x that may seem expensive at first, Broadcom’s earnings growth trajectory of 20-30% per year makes it an attractive investment. The company is exceptionally well positioned to benefit from the AI revolution, with increasing global spending on AI-focused hardware a potentially multi-decade opportunity. Broadcom’s recent financial performance, driven by its strong exposure to AI and successful integration of VMware, supports this statement. With management focused on even higher AI-related revenues and margin expansion, the outlook remains strong. Furthermore, its undervaluation compared to AI peers, combined with its consistent free cash flow generation, further strengthens the case for owning Broadcom at these levels. Analysts currently expect earnings growth of almost 30% year-over-year next year, and with a robust pipeline in AI networking solutions, I think the company’s future growth is still far from fully realized. For a company that delivers such consistent earnings growth and substantial cash returns to shareholders, Broadcom remains an attractive buy at its current valuation.
