Potentially, is this Artificial Intelligence (AI) company's stock set to match Nvidia's success?
Potentially, is this Artificial Intelligence (AI) company's stock set to match Nvidia's success?
Broadcom's (AVGO dropping by 0.66%) shares skyrocketed by around 25% following the company's impressive financial performance during Q4 of fiscal 2024 (ending Nov. 3). This renowned custom chip designer and infrastructure software producer has become a prominent beneficiary of the ongoing artificial intelligence (AI) surge, particularly since hyperscale companies are seeking customized solutions to enhance productivity and reduce costs.
While Nvidia's (NVDA falling by 1.74%) all-purpose Hopper and Blackwell architecture AI chips are highly desired in the AI market, Broadcom has managed to carve out its niche. Broadcom collaborates closely with clients to create custom AI accelerators (XPUs) and networking infrastructure specifically tailored to their AI requirements.
Nvidia's AI chip supremacy has played a significant role in boosting its stock by approximately 163% in 2024. Broadcom's shares have also experienced a rise of almost 115% in 2024. Could this AI stock become the new favorite on Wall Street, potentially surpassing Nvidia's position? Let's explore the possibilities.
Custom AI accelerators and networking services
Fiscal 2024 has been an outstanding year for Broadcom. Revenue increased by 44% year-over-year to hit a record high of $51.6 billion in Q4. The AI sector, which encompasses custom AI accelerators and AI-optimized networking solutions, was a significant growth driver. Revenue for the AI sector surged by 220% year-over-year to reach $12.2 billion in fiscal 2024.
Broadcom has demonstrated remarkable technological prowess by developing next-generation XPUs using 3-nanometer (nm) process technology. The company is capitalizing on both computing and networking opportunities.
Current AI infrastructure setups featuring 500,000 XPUs allocate just 5% to 10% of their resources to networking content (hardware and software) compared to computation content. However, with Broadcom's top three hyperscale clients planning to deploy nearly 1 million XPUs by 2027, 15% to 20% of resources will be allocated to networking content. Broadcom is well-positioned to exploit this opportunity, thanks to its expertise in scaling AI infrastructure (connecting XPUs within and across data racks) and strong customer engagements.
Broadcom forecasts its AI serviceable addressable market (SAM) for XPUs and networking infrastructure to reach between $60 billion and $90 billion by 2027. Furthermore, Broadcom has secured projects with two additional hyperscale clients, whose next-generation XPUs are expected to generate revenue before 2027. This will expand Broadcom's AI SAM.
VMware acquisition
Broadcom has enhanced VMware's operating margin from 30% before the acquisition to an impressive 70% within a year of the deal closure. The company drastically reduced VMware's quarterly expenses from an average of $2.4 billion pre-acquisition to $1.2 billion in the fourth quarter. As a result, the company is on track to exceed its $8.5 billion incremental adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) target, ahead of the initial three-year target post-deal closure.
Broadcom has also fortified VMware's data center virtualization business. Data center virtualization involves creating virtual data centers on a single physical server to optimize resource utilization.
Since the acquisition, Broadcom has subscribed over 4,500 of its largest 10,000 clients to VMware Cloud Foundation (VCF), enabling them to establish private cloud environments on their on-premise IT infrastructure. The annualized booking value (ABV) for VMware is expected to increase from $2.7 billion in the fourth quarter to more than $3 billion in the first quarter of fiscal 2025.
These initiatives have helped Broadcom reduce its dependence on the semiconductor business by strengthening its position in the enterprise software market.
Valuation
Broadcom is currently trading at about 20.6 times its trailing-12-month sales, significantly higher than its historical five-year average P/S multiple of 11.68. However, the elevated valuation is justified considering Broadcom's exposure to robust AI-driven tailwinds. Furthermore, Broadcom's valuation is lower than Nvidia's P/S multiple of 27.75.
Can Broadcom become the next Nvidia?
Despite targeting the same AI infrastructure market, Broadcom has some ground to cover before it topples Nvidia.
Nvidia controls 70% to 95% of the AI chips used for training and deploying large language models. Nvidia has effectively transitioned its large GPU-installed base from training to inferencing (executing models in a production environment) with the assistance of software frameworks, libraries, and algorithms.
With hyperscalers and enterprises seeking to optimize their AI investment, many may prefer to stay with Nvidia rather than switch to Broadcom. Additionally, Nvidia has built a comprehensive ecosystem of hardware, software, and support services. Consequently, the company is well-positioned to capture additional share in the AI market.
Considering these factors, I believe it may take a few more years for Broadcom to match Nvidia's position in the AI market.
In the realm of investing and finance, many analysts are debating whether Broadcom's impressive performance in the AI sector could make its shares the new favorite on Wall Street, potentially surpassing Nvidia's position.
Following the company's acquisition of VMware, Broadcom has managed to enhance VMware's operating margin significantly and reduce its quarterly expenses, positioning itself to exceed its $8.5 billion incremental EBITDA target ahead of schedule.
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