With a cash position of more than $3 billion and another $2 billion in operating cash flow, Broadcom now has its eye set on the emerging "Internet of Things" market, or IoT. This makes sense and could push the stock towards $50 in the next 12 to 18 months.
Why should you invest in Broadcom? For one thing, the shares, at around $41, are up 37% for the year to date.
Another reason is that, according to research firm Gartner, by the year 2010 IoT will grow to 26 billion units installed, representing roughly 30-fold jump from less than one billion units five years ago. Peter Middleton, Gartner's research director, believes this will translate to roughly $2 trillion in global economic value.
Broadcom, whose baseband/wireless business was struggling with high-end device saturation and low average selling prices, saw an opportunity it couldn't pass up. It wasn't worth risking a bigger piece of a larger pie just to stay in a baseband business that was struggling just to break even. IoT gives the company a new start.
The "Internet of Things," which was first used more than a decade ago by British tech pioneer Kevin Ashson, refers to objects and devices that are virtually represented in the Internet. If this sounds complicated, you shouldn't worry. It will soon become a household term, helped by -- among other things -- Apple's (AAPL) - Get Apple Inc. (AAPL) Report recently-launched "HomeKit," which will automate various household functions.
Companies like Broadcom plan to demystify that concept. Likewise, Intel (INTC) - Get Intel Corporation (INTC) Report understands its importance and is investing heavily in that area. Qualcomm and others are likely to follow. Still, it's tough to see how Broadcom will not emerge as a leader in this relatively new category.
This is because Broadcom, by having already designed chips for Apple partners to build things like garage door-openers, has a slight lead in this area over both Intel and Qualcomm. These smart devices will require connectivity. So it makes sense for Apple to look to Broadcom to design chips to integrate home devices/appliances to support its HomeKit.
With Qualcomm (QCOM) - Get QUALCOMM Incorporated Reportdominating the mobile phone market and growing its share as Apple and Samsung (SSNLF) battle over device dominance, Broadcom didn't see enough value in its market position to cover the cost it takes to operate the wireless business.
It turns out Broadcom management made the right decision. Broadcom stock is up almost 17% since the announcement. The shares are trading near their 52-week high.
First, by exiting the mobile/wireless business, Broadcom management can now focus new growth opportunities in connectivity such as in-home automation or wearable technology.
Second, this is still a highly fragmented space. There are several manufacturers pushing their own proprietary home automation platforms that, in some cases, makes it difficult for hardware to talk to software. To the extent that Apple's ecosystem can address this problem by bringing a unified standard, Broadcom stands to gain significantly.
Last but not least, by exiting the baseband business Broadcom is now projected to save as much as $700 million in annual operating expenses. This is roughly 20% of the company's total expenses. Of that total, management plans to reinvest $50 million to grow the rest of the business.
This means that $650 million will be available to grow shareholder value, whether via share buybacks or dividends. Broadcom will have enough capital to consider potential acquisitions. With the stock trading at just 12 times 2015 estimates, which is less than half the industry average P/E, according to Yahoo! Finance, there's also minimal risk.
At the time of publication, the author was long AAPL, although positions may change at any time.
This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
TheStreet Ratings team rates BROADCOM CORP as a Buy with a ratings score of B. TheStreet Ratings Team has this to say about their recommendation:
"We rate BROADCOM CORP (BRCM) a BUY. This is driven by multiple strengths, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its compelling growth in net income, largely solid financial position with reasonable debt levels by most measures, expanding profit margins, solid stock price performance and notable return on equity. We feel these strengths outweigh the fact that the company shows weak operating cash flow." You can view the full analysis from the report here: BRCM Ratings Report