Broadcom's CEO Steps Down and Shares Follow

Updated from Jan. 23

Despite beating expectations both on sales and guidance, Broadcom ( BRCM) shares dove today as investors digested the bigger news that longtime CEO Henry Nicholas is leaving his post. His departure became effective yesterday; COO Lanny Ross will fill in while the company looks for a permanent chief.

In early afternoon trading, shares tumbled $2.74, or 16%, to $14.87.

A day after Broadcom reported earnings, Merrill Lynch slapped a sell on the stock on the basis of its high valuation and Nicholas' departure.

In a note, analyst Mark Lipacis pointed out that at Thursday's close of $17.61, the stock traded at a heady P/E ratio of 84 times his 2003 EPS estimate and 41 times his '04 estimate.

He also voiced worries about the effect of Nicholas' departure. Nicholas "is known as being a strong leader, a great motivator, and in many ways drove the intensely competitive culture of the company," wrote Lipacis. "While we believe that the current management is capable, we believe that with the departure of such a strong leader, the company will undergo a cultural change, if not a bit of a leadership vacuum."

Others called the announcement unexpected but seemed less concerned about the transition to a new CEO in the longer term.

"It's definitely a surprise. I'm sure the Street will miss him," said Ambrish Srivastava, an analyst at Gerard Klauer Mattison, which hasn't done banking with the company. "To give him credit, he's built Broadcom into a true powerhouse." One encouraging trend: The company has lately taken pains to show it's focusing more on the bottom line, Srivastava added. That includes a major cost-cutting effort that included a 16% reduction in staff, announced in November.

Pacific Growth Equities' Jim Liang said that in retrospect, Nicholas' departure might come to be seen as a "non-event," pointing out that all tech companies eventually see their founders leave. "The departure certainly does not come at a bad point for the company. They're guiding for pro forma profitability for the first time in eight quarters," he said. "My interpretation of events is that Nicholas is not leaving because the company is in trouble. That's an important point."

Pacific Growth Equities has no banking relations with Broadcom.

As for the fourth quarter, the company turned in revenue of about $296 million, up 2% from the prior quarter and 31% over the same period last year. Sales came in slightly above expectations of $290 million.

The communications chipmaker lost nearly $1.8 billion for the quarter, or $6.40 per share -- far worse than last year's loss of $1.27 a share. The loss for the most recent period reflects special charges including a noncash goodwill impairment charge of $1.2 billion and a restructuring charge of $88 million.

Broadcom posted a pro forma loss of 2 cents a share, above consensus estimates for a loss of 3 cents.

On the conference call, Nicholas explained the sales upside, saying the company "saw a little better strength than expected, particularly in networking and emerging businesses, with growth led particularly by switching and Gigabit."

In the fourth quarter, networking chips accounted for more than 35% of Broadcom's revenues, with the cable and server lines each contributing under 25%. Nicholas said the latter two businesses were "off some, as predicted."

Emerging business, which includes wireless LAN, accounted for about 16% of sales.

In the first quarter now underway, said Nicholas, "We have seen continued modest strength," citing sound growth in 802.11 products, mobile communications chips and gigabit Ethernet.

As a result, the company is aiming for sales to grow 3% to 5% sequentially. Combining that with a reduction in operating expenses following layoffs, it's gearing to record a small pro forma profit. If so, that would mark a turnaround from seven straight quarters of EPS losses.

Liang noted the guidance is better than his expectation for 2% growth, plus it comes on top of fourth quarter sales that surpassed estimates. "That's nothing to be complained about," he said. Still, Liang has an equal weight on the stock, based on its heady valuation.

Srivastava likewise considers the stock pricey, trading at around 5 times sales -- though that's far below its absurdly high five-year median price-to-sales multiple of 24 (which covers the bubble period when Broadcom changed hands in the $300 range). To put that in perspective, he has a buy rating on Agere ( AGR.a), which claims a far more reasonable P/S ratio of 1.4.

"You can swallow a higher price to sales if you believe there's significant opportunity for appreciation in multiples," he explained. But that's not yet the case for Broadcom. "There are pockets of positive surprises, but the overall end markets are still pretty challenging. I'm not very convinced cable is ready for a comeback, and it's 25% of the business."

In other news, Broadcom said that in the fourth quarter, three customers accounted for more than 10% of sales: H-P at 15.95% of revenues; Motorola at 11.1%; and Dell at 10.7%. But Cisco, which had contributed nearly 12% of sales in the prior quarter, slipped out of the 10%-plus category.

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