Broadcom has jumped 13% this week after announcing on Monday morning that it planned to exit its cellular baseband business. This Bloomberg article from Monday had the details:
Broadcom Corp. (BRCM), struggling to make a dent in Qualcomm Inc.’s lead in chips that connect smartphones to mobile networks, said it’s giving up on that business. The company hired JPMorgan Chase & Co. to help explore options for its cellular baseband unit, including a possible sale. Exiting the business would reduce annual expenses by about $700 million, Irvine, California-based Broadcom said today in a statement. The shares surged 9.3 percent, the biggest one-day gain since 2011. Broadcom is the latest company to say it won’t try to compete in baseband with Qualcomm, whose chips connect the majority of smartphones to high-speed, Internet-capable networks. Texas Instruments Inc. and Freescale Semiconductor Ltd. have already dropped out of the industry, and Intel Corp.’s latest quarterly report showed that its losses exceeded revenue in the mobile-chip business.
BRCM management also raised their margin guidance and reiterated the sales guidance. The stock’s strong reaction has been in contrast to the reaction from the analyst community. Since Monday’s announcement, 3 analysts have upgraded the stock and 3 analysts have downgraded it (including 1 upgrade and 1 downgrade this morning). But investors are pleased so far. The positive reaction in BRCM could be telling for other tech companies with many diverse business units. We wrote extensively about BRCM in a December Deep Dive post, and mentioned the company’s diversification:
Broadcom is a chip company that primarily supplies circuits for cable set-top boxes, cable modems, direct satellite and digital broadcasts, and digital subscriber lines. The company offers 600 products grouped into 60 different product lines. The company is split into 3 main reporting segments, each with about an equal share of profits.
That’s an awful lot of products to manage. Even as BRCM has grown sales in 9 of the past 10 years, the stock has hardly moved, and earnings have been stagnant since 2010. Perhaps the market’s reaction is a welcome sign from investors that management is finally getting more focused on profit growth rather than sales growth, and the sale of the baseband unit is simply one small step in the process of becoming a leaner, more efficient company. Whether that long-term plan comes to pass or not, the desire among investors for more focus, more efficiency, and higher margins over top line growth likely holds true for not just BRCM, but many other legacy technology companies as well.
Companies like EBAY, YHOO, GLW, SUNE, etc. are also viewed as situations where the stock might be better off if certain divisions were spun off or monetized (Paypal for EBAY, Alibaba and Yahoo Japan for YHOO, the non-display divisions for GLW, the recently spun off semiconductor business at SUNE). These sum-of-the-parts situations are prime targets for activists, and they are surely on the prowl for just these types of companies even as we speak. The reaction in BRCM is case-in-point why activist investors get excited about “unlocking value” through spinoffs or wind-downs or other reorganizations of that sort.
In such an environment, overall business investment might remain weak. Investors are rarely rewarding companies for expansion, but rapidly rewarding companies and management for contraction. Even the former high flying momentum stocks, which were largely given a pass on the bottom line if top line sales growth remained strong, might be pushed more aggressively by the market to show us the profits. With that in mind, we’ll be on the lookout for more situations where a bloated conglomerate might be bait for the crowded activist sharks frantically searching the investment waters.