Avago Ascends With Acquisitions As Wireless Goes 4G


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Avago Technologies, a maker of radio-frequency chips for mobile devices, is poised to benefit from rollout of 4G wireless networks in heavily populated markets such as China. It's also apt to see large-scale cost savings from a recent, transformative acquisition.

Singapore-basedAvago 's ( AVGO ) stock is up about 35% this year, recently trading around 72, and the company gets a highest-possible Composite Rating of 99 from IBD.

Large swaths of Asia, notably including China, are in the early stages of deploying higher-bandwidth cell-phone standards, moving from so-called third generation to fourth generation, or 4G. China's massive population creates the possibility for long-term demand from customers for new mobile devices as this move unfolds. Avago, by extension, could see demand for its chips boosted commensurately, analysts say.

Avago "has an important play on the switch to 4G," RBC Capital Markets analyst Doug Freedman said in an interview.

For its second quarter of fiscal 2014 ended in May, Avago reported revenue of $701 million, up 25% from a year earlier and ahead of analyst views for $678 million. Earnings came in at 85 cents per share ex items, up 39% year over year and well ahead of Wall Street's expectations for 76 cents per share.

Building On Acquisition

Both profit and revenue growth have advanced for four consecutive quarters, and the company is expected to extend that streak. For its current quarter, Avago has estimated revenue of $1.3 billion to $1.4 billion, which would be more than double the year-ago quarter.

Analysts polled by Thomson Reuters on average predict EPS of $1.04 for the current quarter, a 41% year-over-year rise. Among 23 analysts who cover Avago, four have a strong buy rating, 14 have a buy rating, and five say hold the stock.

The big bump in sales anticipated in the current quarter would come as Avago includes for the first time contributions from its $6.6 billion May buy of LSI Corp., a maker of semiconductors and software used in storage and networking gear.

Avago CEO Hock Tan, speaking with analysts after reporting earnings in late May, called the LSI deal a "transformative event in Avago's history" that created "a substantially larger company with a much more diversified and balanced mix of end markets."

Avago produces chips for wireless and wired communications as well as industrial, automotive and consumer electronics. Its top customers includeApple ( AAPL ), Samsung,Cisco Systems ( CSCO ),Hewlett-Packard Co. ( HPQ ) and Siemens.

Business Mix Changes

Before the LSI takeover, about half of Avago's revenue came from wireless communications products -- nearly a third from wired infrastructure customers and the rest from industrial and other segments. The large wireless customer base is fertile ground, but it also has been volatile at times, analysts say, as demand for products such as smartphones ebbs and flows with advances in technology and rollouts of new devices.

The combined company now has "about 50% of its revenue tied to stable businesses (storage and industrial) and 50% tied to growth businesses (wireless and wired infrastructure)," Romit Shah, an analyst at Nomura Private Equity, wrote in a report.

Avago's stock has been riding high this year, in part because of the $200 million in annual cost savings that the company expects from the LSI deal by the end of its fiscal 2015, says Thomas Diffely, an analyst at D.A. Davidson.

"We're in a market right now where investors really like the prospect of cutting a bunch of costs," he said in an interview.

Tan said on the May conference call that the integration of LSI was "still progressing" heading into the summer months, "but progressing very well." He said Avago was "very much on track" to achieve the cost savings as planned.

Avago also has begun to divest some LSI assets. At the end of May, the company said that it would sell LSI's Accelerated Solutions division and its Flash Components division to disk-drive makerSeagate Technology ( STX ) for $450 million.

Avago also remains a buyer, looking to deepen its diversification play. The company announced Monday that it plans to acquirePLX Technology (PLXT) in an all-cash deal valuing PLX at about $300 million. The transaction, expected to close in Avago's fourth quarter, is projected to benefit Avago's adjusted EPS immediately while broadening its networking and storage offerings, the company said.

M&A Trade-Offs

With these deals, Avago is working to build out its chip-development business in the data-communications and telecommunications markets.

While many on Wall Street welcomed the effort to diversify and offset volatility as a positive for the long term, it cuts Avago's exposure to the wireless business roughly in half at a time when wireless revenue could swell. That means that the combined company -- while larger and packed with potential for greater sales -- may not grow in coming quarters as fast as it has in the recent past, some analysts say.

The wireless segment accounted for 50% of Avago's total revenue in the last completed quarter, as wireless sales ballooned 25% year over year. For the current quarter, wireless revenue "will be a little over 25%" of total revenue, Tan said on the May conference call.

The LSI deal, while a big positive on the cost-savings front, effectively scales back what had been the major driver of core growth, at least when looking at percentage advances, Diffely says.

"It dilutes a nice growth story," he said, adding that he recently downgraded Avago stock from a buy to a hold recommendation. "We really did like their position before. ... We still like it; it's just that there's not as much upside for the stock from here."

Ringing-Up New iPhone 6

Freedman, the RBC Capital Markets analyst, noted anticipation for an Apple iPhone 6 rollout as soon as the second half of 2014. That launch will drive wireless business not just in Asia but also in North America, Europe and elsewhere.

While it certainly stands to benefit Avago, Freedman says, the benefit will be less now in terms of its share of revenue growth for the company. Following the LSI deal, Freedman adds, Apple shrinks from close to 20% of the Avago customer base to about 10% .

Given the proven popularity of the iPhone and similar products from Apple and competitors such as Samsung, Freedman said, a diluted exposure on that front could concern some investors.

"It's still significant; I would never say Apple is not significant," he said. "But it is markedly less significant (to Avago) than it used to be."

That noted, both Freedman and Diffely said that Avago is a company on sound footing with an eye toward long-term staying power.

"We still feel very comfortable about the fundamental drivers of the company," Diffely said.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Investing Ideas
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