Barron's Streetwise - Broadcom Cracks the S&P Top 10. What’s Next?

Episode Date: June 7, 2024

Plus, telecom is going bananas for fiber broadband. UBS analyst John Hodulik discusses what it means for cable.  Learn more about your ad choices. Visit megaphone.fm/adchoices

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Just imagine that you're talking to a friend in a coffee shop on a roller coaster. Hello there. Welcome to the Barron Streetwise podcast. I'm Jack Howe, and the voice you just heard is John Hudlick. He's a telecom and cable analyst at UBS, and he's talking about a fiber broadband land grab. In just a bit, we'll hear about that and what it means for cable stocks. Before that, we'll say a few words about a certain AI chip maker. Not that one. Or that one. Another one.

Listening in is our audio producer, Jackson. Hi, Jackson. Hi, Jackson. Hey, Jack. Did you hear the big news about NVIDIA every week? Because that's all people talk about. It's all NVIDIA all the time. But this week, of course, what? It topped $3 trillion in market value, and it passed Apple to become the second biggest company in the S&P 500.

value and it passed Apple to become the second biggest company in the S&P 500. I remember early in the pandemic, we had NVIDIA founder Jensen Wong on this podcast. That was 2020. And I distinctly remember you telling me that you had sold everything you owned at that point and put it all in NVIDIA. You were going to hold it forever. Have I got that right uh no unfortunately not yeah i'm sorry well the stock's up it's only up 1200 since then so don't worry you still got the parody crypto and the cartoon ape faces right 1200 percent's nothing compared to dogecoin now did you hear about the other ai chip stock milestone this past week. Oh, I don't know. This one snuck in there. I don't know how many people are watching Broadcom,

but it became the number 10 company in the S&P 500 by market value. Did you know that? Bigger than JP Morgan, bigger than Exxon Mobil, edging out Tesla. Wow, that's impressive. And Broadcom wasn't always an AI stock, but this latest move has everything to do with AI. Let me see if I can simultaneously give myself a pat on the back and a kick in the rear end, because I did write a positive story, a few of them, in fact, in Barron's starting back in 2016 about

Broadcom and the stock is up 900% since then. So it has outperformed the S&P 500 by more than 700 points. But there again, if I were a good stock picker at all, I would have said, forget about Broadcom and buy NVIDIA and people would be up 7,000%. Also, the stuff that I liked about Broadcom back at the time, like a lot of free cash flow and dividends and stuff, that sounds almost ridiculous now because all of these latest gains are coming from AI. Nobody cares about the dividend. So let me explain about what Broadcom is. I've described it as a tech turducken, if I may use that term. The thing with it, what does it have? A chicken, a turkey, and a duck?

Not necessarily in that order. But this one is for semiconductors and software. Hewlett Packard once spun something out that was called Agilent Technologies. And then the private equity bought this semiconductor part of that and called Agilent Technologies. And then the private equity bought this semiconductor part of that and called it Avago. And they put this person named Hoctan in charge. And Hoctan is kind of a serial acquirer. He did a ton of deals, most of them small, a few of them were big. The biggest was the purchase of California chipmaker Broadcom in 2016. And Avago took Broadcom as its name, but it kept AVGO as its ticker.

That's if you're wondering why the ticker doesn't seem to match the stock, that's why. So what I wrote shortly after that Broadcom deal was, hey, look at the stock. It's only 14 times free cash flow. It's cheap. And back then, the big deal was Broadcom was making innards for smartphones, and the iPhone was booming. So Broadcom was riding that higher. And in stories after that, I wrote, you know, this is a pretty good thing the company has going with a serial dealmaking, because in chips, in a lot of industries, in fact, what

you can do is you can look for companies that have high gross margins, but so-so operating margins. Gross margins tell you at the product level what's going on. After you've spent the money to make whatever it is you're selling, what do you have as a profit? So if you have high gross margins, it means customers like your stuff. You've got pricing power. Operating margins take

out for your corporate overhead. So if you have high gross margins, but low operating margins, it means customers like your stuff. But for whatever reason, either you're spending way too much to support the company or you're just not big enough. You're not getting any kind of leverage on your corporate spending. That happens a lot for subscale tech companies. And there's an easy fix for that. It's for the company to be gobbled up by someone bigger, and they get rid of the corporate cost, and what's left over are those products with the attractive gross margins. And if you do that again and again, you can build quite a bit of free cash flow. Investors eventually got a little worried about Broadcom because it started to do

software deals. It started to get out of its core expertise in chips. It bought something called Computer Associates and later Symantec and last year VMware. And that has brought software for networking and security and cloud computing. But again, this is not necessarily related to why the stock has been shooting higher recently. What people like about Broadcom, I think, is chiefly something called an ASIC. And I am not a semiconductor expert, but I'm going to do my best trying to explain this. ASIC stands for Application Specific Integrated Circuit. One of the reasons NVIDIA is taking over the stock market is because they developed these highly parallel processors that were useful for making video game graphics.

And then it turned out that those types of processors were just about ideal for the job of mining cryptocurrency and, more importantly, for artificial intelligence, where you set machines loose digging through big piles of data to learn stuff. And if you're a company that right now wants to invest in AI, you can build infrastructure and you can buy some NVIDIA chips. They're off the shelf chips and you can do a lot of different things with them. But if you're one of the very largest customers, a company like, let's say, Alphabet, then number one, you can afford to make your own chips as long as you have some outside help for the AI acceleration. And number two, you don't really need general chips that can do lots of different things. You need highly specific chips that can do one or a few things. And you can afford to have those chips made for you to do just what you want them to do. That gets you the

best performance and the lowest power consumption for the best price and those chips are custom asics and broadcom makes the best ones it's the market share leader in high-end custom asics it has an estimated market share of 55 to 60 percent the number two player is marvel technologies which is maybe around 15%. And ASICs aren't Broadcom's only AI-related business. The company has a few decades of experience in high-speed networking. And you really need that with AI because you might be grouping together thousands of accelerators to do this hard thinking together. So if you look at Broadcom as a whole, the company is projected to reach more than $50

billion in revenue for its current fiscal year. That ends October. And that number is up from just under $36 billion in the previous year. Of that, J.P. Morgan estimates that AI revenue will be $11 to $12 billion this year, and that it will rise to $14 to $15 billion next year. And there's plenty of growth expected beyond that. JP Morgan writes that these hyperscale companies, companies like Alphabet, are increasingly turning to their own hardware in order to save cash and get good performance, and Broadcom is a key company they partner with.

Among Broadcom's customers, Alphabet is by far the largest for AI uses. Meta is coming on strong. And there's also a third unnamed one that Broadcom is ramping up this year. Some analysts believe that that is the TikTok owner ByteDance. There are other customers beyond that, including Microsoft and Apple.

By the way, Jackson, one fun fact I forgot to mention when I first wrote about Broadcom in Barron's in 2016, it was one third the size of Intel by market value, and now it's five times the size of Intel. I should have said, fun fact for everyone but Intel. So what does all this mean for Broadcom stock? Well, I'm not the guy to tell you. As we've already discussed, I'm not a super duper stock picker. I can say that it is about twice as expensive as it was when I first looked at it relative to free cash flow. It's around 30 times free cash flow.

That's an ambitious price. But there's fast growth there. And NVIDIA stock is closer to 50 times free cash flow. And Nvidia stock is closer to 50 times free cash flow. An investment bank called Mellius Research initiated coverage of Broadcom this past week. It was fairly glowing coverage, and they think that earnings per share could hit $70 within a few years. That's compared with about $42 and change last year. $2 and change last year. And they say that they think the stock is headed in the near term to $1,850, up from a recent $1,400. JP Morgan is bullish, but not quite that bullish. They think

the stock is headed to $1,700. I don't know if any of that's going to happen. It depends on what the stock market does. For that, you probably have to ask AI Google and there goes Broadcom making money from that again. And that's Broadcom. Let's turn our attention to fiber broadband, but maybe a quick break first. Jackson, you told me that you're going to make a smoothie during the break. Is there anything you'd like to share with the group

about what you plan to put into your smoothie? There's going to be fruit. Some frozen bananas. Okay. Spinach. All right. Stop. Stop.

I've heard enough. We'll be back right after this break. I will. I don't know about Jackson. Welcome back. Let me tell you about my fiber broadband service. This will not take long. I think it costs, I want to say $80 a month.

It comes from a phone company that also does my cell phone service. I think they give me a price break on it. I can't, I don't think I've spoken with them in years. The thing just works all the time. It's a steady, stable connection or whatever. I don't, I don't think I've spoken with them in years. The thing just works all the time. It's a steady, stable connection or whatever. I don't have any complaints. And if I want to cut costs somewhere, I'm definitely going to be maybe canceling a streaming service or two.

I'm not going to uproot the whole internet connection that, you know, my online life depends on. It just seems like something that I don't want to monkey with. And I think that I am't want to monkey with. And I think that I am not alone in feeling that way. As I understand it, this business, fiber broadband, has exceptionally low churn. Customers just tend to forget about their service and stick around. And prices have increased over time, and it's turning into a lucrative business for telecom companies. Those companies have already spent loads of money to build out their 5G networks, and now they're

finding that the returns are attractive for bringing more fiber broadband closer to more homes. And I saw a report on that recently from UBS, and it got me thinking about what it means for cable companies, right? Because if you're looking at a cable stock, you say to yourself, okay, I know that people are canceling their pay TV service, their cable bundles. They're saying, I don't need that TV anymore. I've got streaming. But they're saying, let me keep my broadband. And I have heard that for cable companies, the broadband service is high margin service.

They don't especially mind if you cancel your TV package and you keep your broadband, they're still making good money on you. But what happens if a telecom company rolls into town with shiny new fiber, and now you have another option for your broadband service? That's got to be bad long-term for cable companies, no? Those were my questions, some of them, and for answers, I reached out to UBS analyst John Hudlick. Let's listen to that conversation now. See if you can tell the part where Jackson chimes in with a question of his own. It's kind of like an audio, where's Waldo? So I have something called Verizon Fios.

I think I know what fiber to the home is and what it does. And your report says that we're about to see a lot more of it. Why is there the sudden urgency in bringing this to more customers? Fiber-to-the-home deployment in the U.S. has sort of gone in sort of fits and starts and, you know, sort of accelerates, then it slows and it accelerates. And you're right. Our view is that you're about to see another acceleration, largely due to wireless carriers, again, seeing the fiber to the home opportunity as economically attractive. I know all the wireless carriers just spent a ton of money to build out their 5G

networks. And my understanding was that we're reaching a period where they're now going to see the fruits of all that spending in terms of rising cash flows. So how does this choice to deploy money on fiber, how does that compare with spending the money on 5G? Is it as good of a deal economically for them? I actually think it's better. And you're right about that. So we have this sort of big wireless CapEx sort of spending wave,

A, to deploy a lot of new spectrum that came available, and B, to switch from 4G to 5G. But I would say the incremental revenue you get from 5G as it stands now is not quite what people expected. I think the carriers thought there'd be all this mobile edge compute, network slicing, private 5G, all that stuff is much more slow to develop than expected. We still think it will develop and will become a nice revenue stream. But at this point, we're not really seeing much of it yet. But I think the CapEx has come down and that creates a little bit of room within their CapEx budgets to spend more on fiber to the home.

And the economics of fiber to the home have gotten better for a number of reasons. One, as you've probably seen, cable broadband ARPU continues to increase three plus percent a year. So average revenue per user. You got it. Average revenue per user. Your broadband bill is getting more expensive a year. So average revenue per user. You got it. Average revenue per user. Your broadband bill is getting more expensive every year. Part of its price increases. Part of it's because a lot of people are electing to choosing faster speeds, one gig speeds, for instance. Those prices that are being paid are very different than when Verizon laid Fios

in your neighborhood 10, 15 years ago. And for the benefit of people who won't see your report, what kind of an increase are you looking for? Like how widespread is fiber broadband service today? Where do you expect it to be in a few years? And, you know, is it catching up with cable? Yeah, that's a great question. So right now we think it's about 50%, about half of U.S. households. And we think by the year end 28, it'll be 80% of U.S. households. Now, cable, with our cable modem service, is probably 90 plus, maybe even 95% of U.S. households. So it's fully deployed. It's two-way. It's currently going through another round of upgrades to improve the speeds, especially the upstream speeds. So they're

not standing still at all. And they're actually extending their network into those unserved areas. But fiber is catching up. And tell me about the sales pitch. If you're a telecom and you've laid fiber in a new area and now you're going to go up against cable. I gather that fiber maybe can be a little faster or better on the connection. You can tell me that. But also, you're going to do some bundling, right? I mean, cable is traditionally bundled with pay television. Some people are canceling their pay television subscriptions, whereas telecom, I would imagine they're going to be bundling with their wireless service. Have I got that right? You're right. Cable started out really as, you know, as a linear TV service that is in significant decline. We think that

total linear TV packages in the United States right now are a little over 70 million out of 130 million households. So, and traditional linear TV packages are quite a bit lower than that. You know, there's the streaming version is taking a lot of share. That's YouTube TV, H live sling tv that that kind of thing so so that business is in the climb for the cable companies and they've really converted to become predominantly broadband companies serving the residential market and and the business market now fiber comes in fiber optic sells first of all it's it's kind of the new thing i think there are are some benefits to fiber optic based broadband service at home versus cable. Upstream is definitely better. They also come in with promotional pricing. That's meaningfully lower than what you would get from an incumbent cable modem service.

But you're right. I think the next round, you're going to see a lot more bundling with wireless. That's the new bundle. Home broadband and effectively mobile broadband, or what we think of today as mobile wireless. The cable companies are doing it from their side. They're reselling a wireless service. You have Xfinity Mobile out there, Spectrum Mobile, which is a resold Verizon product. And now you're increasingly going to have the telcos not just selling wireless, but selling fixed wireless-based broadband and increasingly fiber-based broadband. Can you give me a sense of the scale

of those two selling the fixed wireless where you get kind of a cell phone signal to handle your internet connection for your home versus selling a fiber line to your home? I would guess that the wireless service is still pretty small, right? I mean, is it catching up or? It's sort of 10 million-ish, a little over 10 million. I think we've got 12 million by year end. And that is predominantly being sold by T-Mobile and Verizon. You know, we talked about all the new spectrum that came on the market and is being deployed by the wireless carriers. And then the move from 4G to 5G, those two things created a lot of capacity in wireless networks in the United States. And those two carriers are monetizing that capacity by selling fixed wireless broadband

access to the residential market, increasingly to the small business. Now, in terms of positioning that product, I would say fiber is on the top. Then you have sort of cable, which occupies the middle. And then fixed wireless is at the low end. It's a lower end product. It's slower speeds. I think there are going to be capacity issues over time, but it's much cheaper. So you've got this sort of, you know, three layered sort of market. You know, the big question is, you know,

how thick is each layer if we look out five to 10 years? And how much more data demand is there now than say five, 10 years ago? Is it significantly higher? Oh, gotcha. Oh, gotcha. It's just, just think of what you're doing at home. You're, you're not watching linear TV over cable anymore. You're watching streaming, not just Netflix, but a lot, maybe you have YouTube TV. And it better be 4k by the way. My vision's terrible, so I can't tell the difference,

but it's still, I need it to be 4k. A hundred percent. So it used to be standard def 10 years ago, then it moved to HD. Now it's increasingly 4k. So not just are you watching streaming over the internet instead of over a private cable network, you're watching much higher resolution and you're actually, you know, the kids are on their phones, they're, they're gaming. You're on the Peloton. You've got more devices, more video, and higher quality video. And that's really what's driving it. It's all video is what's really driving things. So you're a stock analyst.

And my question, of course, is what does it mean for the stocks? And there's really two parts. Is this a big enough deal to sweeten any of the cases for the telecom stocks and for the cable companies. I think what I've heard about a lot of the cable companies is, yes, you know, pay TV is shrinking, but don't worry, broadband is very profitable for us. It'll still be a good business going forward. Does this change that thesis for cable companies? Let's start with cable. I don't think it changes the attractiveness of the broadband business for cable.

I think broadband is still going to be a great business for the cable companies. Like you said, it's high margin. The subscriber acquisition costs are relatively low. They mostly drop ship your modem. You don't need to roll a truck out there. It's a good business. The problem is it's now a competitive business. If we go back pre-COVID, the competitive fiber footprint was

much smaller and there was no effectively fixed wireless in the market. So that three layers really didn't exist to the extent it does now. So I think it's a more competitive business. Right now they're losing subscribers. We think that that's going to certainly continue for the rest of the year. We'll see what happens in 25, but you'll probably see further losses. As it relates to the carriers, yeah, I think the fiber business is a good business. Certainly, the carriers benefit when they roll out fiber in region from some of the existing infrastructure they have, like telephone poles, that kind of thing, rights of way. And again, the economics of providing fiber, especially in denser areas,

is now attractive given the high ARPUs and the fact that you don't need to sell a video package along with your broadband package. So I think it's a positive for the wireless carriers and really all three of them. You know, AT&T is by far the biggest fiber footprint than Verizon with its Fios fiber it rolled out. And what we're saying in this recent note

is that you're going to see T-Mobile sort of join the fray. And it may probably not get to be as big as Verizon is, but be a meaningful player in the space. What are your favorite stocks in the group? We do like T-Mobile. We think the fiber strategy is going to be a good one. It's been growing much faster than the rest of the group. They're also returning a lot of capital

to shareholders through buybacks. But we also like AT&T. We think that as people get more comfortable with the T-Mobile strategy, which we think they're going to unveil in September, people are going to love the AT&T strategy. And that's because not only is AT&T a national wireless carrier, it has by far the biggest footprint of fiber. Right now, the targets are for them to reach 30 million homes. We think that they're going to increase that to 30 million locations.

We think they're going to increase that target to 45 million. So again, you're really thinking of 45 million for AT&T, sort of a little bit less than 20 for Verizon. And in the sort of 15 range is where we think T-Mobile eventually gets. So you've got positive ratings on T-Mobile and on AT&T. Do you cover the cable companies or is that a colleague? No, no, I cover the cable companies as well. Any of those that you like? We're neutral on Comcast and Charter, you know, and really it comes down to the broadband business. The broadband business is the value driver. There's other, especially Comcast, they do other things, right? They're in the media business. They got a great theme park business, a great studio. They own Sky. Charter is a sort of pure

cable, but we're neutral on both because broadband is the value driver for both of those companies. And they're seeing some pressure. It's a very different environment than where we were just a couple of years ago. Thank you, John. Jackson, are we ready to wrap up? Well, I've got fixed wireless for my internet connection. Uh-huh. And I'm not sure how I feel about John calling the thing I have a low-end product. Oh, no. That was hurtful?

It works fine, yeah. Let me tell you something, and I think I'm speaking for John here. What he meant is that you personally are a high-end guy, okay? There's nothing wrong with you. You're the greatest. Your product is, you know, maybe a value offering, but it works well for you, no? Hey, my internet speed is fine. Are you doing a stutter effect?

Listen, you're not the guy from police academy all right thanks to everyone for listening jackson cantrell is our producer you can follow the podcast on apple podcast spotify youtube wherever leave a comment write a review the whole thing you can send a question tape it on your phone, voice memo app. You can email it to jack.how. That's H-O-U-G-H at barons.com. Ooh, that reminds me. I have a big correction. A couple of weeks ago, I mentioned what I thought was another Jack Howe.

He was a distinguished ear doctor. He was a distinguished ear doctor. And then I got an email from another ear doctor who had attended one of this, what I thought was Jack Howe's lectures. And he told me in the email, phonetically, his name was pronounced Huff, H-U-F-F, unlike mine, which is pronounced Howe. And as I've said several times in the past, I have long suspected that my family has come to mispronounce our own name over the years because everyone else seems to say Huff.

I don't know how or why it happened. Maybe there was a lost bet. Maybe one of the Huffs partied too hard 200 years ago and woke up missaying their name. I don't know. Maybe I'm rambling now. Jackson, are we still recording? Unfortunately.

I'll take that as a see you next week