NEW YORK (TheStreet) -- Shares of Avago Technologies (AVGO) - Get Report may have fallen 20% from their all-time high of $150.50 in June, but that simply creates a good buying opportunity right now, because this chipmaker's long-term outlook is bright. Not only is its mobile business growing quickly, but its pending acquisition of semiconductor maker Broadcom (BRCM) looks like a great strategic fit.
Component producers like Avago and Broadcom can be some of the best ways to gain exposure to the ongoing mobile revolution. Avago's $37 billion purchase of Broadcom will create a semiconductor powerhouse with combined annual revenue of more than $15 billion. Broadcom's technology will make Avago even more competitive in communications chips.
Once the Broadcom deal closes (expected by early next year), networking will become Avago's largest business unit. The company says the transaction will immediately add to earnings and claims $750 million of projected annual cost savings, to be achieved within 18 months after the close. Analysts at Pacific Crest say deal synergies will allow Avago to earn $12 a share in calendar 2016.
But for now, Avago is doing just fine on its own, and earnings estimates keep rising.
Since early May, the fiscal 2015 (ending October) consensus estimate for earnings per share has advanced to $8.85 from $8.42, while the fiscal 2016 consensus is up to $9.53 from $9.09. At a recent price of $120.15, Avago shares trade at 12.6 times the fiscal 2016 EPS estimate, down from a forward price-to-earnings ratio of 16.1 at the June peak. The highest Wall Street analyst estimate for fiscal 2016 EPS is $9.88, giving the stock a forward P/E of only 12.1.
Avago's underlying fundamentals are positive, driven by solid demand in the wireless unit, along with expansion into chips and software for enterprise storage via the $6.6-billion acquisition of LSI. Completed in May 2014, the LSI purchase did a lot to diversify Avago's revenue, but the company's wireless business still generates about 40% of sales, thanks to Apple (AAPL) - Get Report being a key customer.
Avago's Film Bulk Acoustic Resonator, or FBAR, filters (a form of bulk acoustic wave filter offering superior performance) account for about 80% of the company's wireless revenue. FBAR technology lets phones operate over multiple bands across multiple regions worldwide, with simultaneous LTE voice and data.
Since 4G/LTE frequency bands are often crammed into very limited space in smartphones (sometimes with little to no guard bands separating each one), FBAR filters allow handsets to co-exist in the presence of frequencies that would otherwise cause interference.
About one-third of Avago's wireless growth is driven by unit expansion, with the remaining two-thirds coming from content expansion within handsets, according to CEO Hock Tan. Unlike with power amps, where a single multimode, multiband solution can support multiple bands, world-roaming smartphones require one filter for each band. When most applications were 3G-based, only four to five different bands benefited from FBAR filtering, but 4G/LTE filter specifications are much more stringent, so Avago now supports as many as 15 different frequency bands with FBAR products, meaning more dollar content in each handset.
For the iPhone 6s and 6s Plus, analysts at Craig-Hallum estimate Avago will generate about $6.75 in revenue per device, up from $6.50 for the previous version of the smartphone. JMP Securities recently upgraded Avago to outperform with a price target of $165 (based on a P/E of 15 applied to expected 2016 EPS of $11) because it expects the chipmaker to see increased content in the iPhone over time. The firm says Avago's content share inside the iPhone 6s and 6s Plus will show a slight improvement and then "advance solidly" next year in the iPhone 7.
We've recently seen acquisition activity similar to Avago's purchase of Broadcom in another segment of the mobile market and even named one of the companies behind it "The Best Tech Stock Under $8."
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.