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Investors Cheering Electronics Chip Gains

Talk about topping a top year.

Shares of Irvine-based chipmaker Broadcom Corp. are up nearly 50% in the first month of 2006.

That follows gains of nearly 50% in 2005, just the second positive year for the stock since the technology bubble in 1999 and 2000.

Even after giving back some of the gains last week, Broadcom’s market value

is hovering around $24 billion, the highest since early 2001.

Investors assign more value to Broadcom than either General Motors Corp., Sun Microsystems Inc. or International Paper Co.

Broadcom’s value is on par with Starbucks Corp.

Thank the technology rebound, driven largely by consumers.

The chipmaker continues to benefit from past bets on consumer electronics while maintaining growth in its more traditional communications chips for networks and set-top TV boxes.

It’s also set to gain from the merging of computer networks and consumer electronics.

Broadcom’s chips are in two of the hottest electronics devices: Apple Computer Inc.’s video iPods and Motorola Inc.’s Razr phone.

“They’ve got the best product cycles right now,” said Ruben Roy with Pacific Crest Securities Inc. in Portland, Ore. “They’re selling to the fastest-growing markets. I think it’s going to be a banner year.”


Raised Outlook

Broadcom earlier this month raised sales guidance for the first quarter. The chipmaker expects sales to rise 6% from the fourth quarter, better than a prior forecast of a slight sequential dip.

The revision was particularly surprising considering companies that count on consumers usually see a slowdown after the holiday quarter.

Wall Street was more than surprised.

“Stunned is probably the right term,” Roy said.

Meanwhile, Broadcom’s fourth-quarter results handily beat expectations. The chipmaker posted net income of $195 million during the quarter, up 174% from a year earlier. Analysts were looking for profit of $152 million.

Sales soared 52% to $821 million compared to a year earlier, topping estimates of $779 million.

“The fourth quarter was a very strong quarter for Broadcom on many fronts,” Broadcom Chief Executive Scott McGregor said in a call with analysts and investors.

The stock rose as much as 25% in afterhours trading following the news. Analysts upgraded their ratings on Broadcom and boosted stock price targets.

A few analysts almost apologized for not getting on the Broadcom bandwagon earlier.

“We fully admit we have been slow to appreciate the company’s growth power and missed upgrading the shares sooner,” wrote Jeff Palmer and Chris Caso, analysts with Friedman Billings Ramsey Group Inc. in Arlington, Va., in a recent report.

With the average rating of “buy,” Wall Street still thinks the stock can go higher.

“I think people are pretty upbeat on their growth prospects,” said Satya Chillara at American Technology Research Inc. in San Francisco. “They are executing and people are paying for that.”

This kind of love was unheard of just a few years ago. Back then, Broadcom was emerging from a steep downturn in the chip sector. And growth prospects for the company’s traditional networking chips weren’t so bright.

Now, it’s chip sales to consumer electronics makers that are growing faster than observers guessed. Analysts see electronics as the catalyst for growth in the chip sector.

“Broadcom has historically been considered a communications company,” Pacific Crest’s Roy said. “It has been progressively diversifying into consumer electronics.”

There’s some concern Broadcom’s shares are getting pricey by one measure: the ratio of price to 2006 earnings expectations.


PE Ratio, Options

Broadcom’s ratio is about 40, in line with another hot communications chipmaker, Marvell Technology Group Ltd. of Sunnyvale. It’s much higher than chip bellwether Intel Corp., whose ratio is 14.

One factor that could impact how investors look at technology shares is stock options expensing.

Even for a tech company, Broadcom is known for handing out big wads of stock options.

Under new rules, financial results under generally accepted accounting principles must include the costs of stock options. Broadcom typically focuses on “non-GAAP” numbers that don’t track options costs.

“In my opinion, that will take three or four quarters before people really start factoring it in,” American Technology’s Chillara said. “People are in that transition period.”

Stock-based compensation would eat up about 45% of Broadcom’s net income in the first quarter, according to Mark Lipacis, an analyst with Prudential Equity Group LLC in New York.

Another challenge: getting all those chips made and shipped at a low price.

Broadcom is a fabless chipmaker,it designs the chips but farms out manufacturing to others.

Although Broadcom’s size gives it power during manufacturing contract negotiations, growth in the overall chip market is making it tougher to line up cheap production. That could put some pressure on gross margins, Roy said.

The company posted a 24.4% operating margin in the fourth quarter, above the target of 20% to 22%, Roy said.

Challenges aside, Broadcom is making big gains in hot sectors.

Sales in Broadcom’s mobile and wireless unit grew 44% in the fourth quarter compared to the third quarter.

That followed 47% growth versus the September quarter for the unit that makes up about a third of Broadcom’s sales.


Bluetooth

Bluetooth is helping drive gains in Broadcom’s wireless unit, which makes up an estimated 15% of overall sales.

Bluetooth connects wireless phones to earpieces, computers and other devices via a wireless link.

Broadcom’s Bluetooth sales are up 40% to 50% during the past few quarters, Lipacis said.

“The opportunity is compelling when you consider that over 700 million cell phones and over 200 million PCs ship a year, each with the potential to drive two or more pieces of Bluetooth silicon,” Lipacis wrote in a note.

Other growth areas include chips for a wireless networking technology called 802.11n, which links consumer electronics at home.

Broadcom’s business of selling chips for servers and networking, which made up 37% of sales in the fourth quarter, grew by 12% in the period.

The company’s broadband unit grew 5% sequentially in the quarter.

The unit includes chips for cable modems, digital subscriber lines and set-top boxes.

The company’s digital TV chip sales are likely to get a boost with the Federal Communications Commission’s mandate that TVs be able to receive digital signals.

“We believe that Broadcom is a prime candidate to benefit from this trend, and already has design wins with Asian (TV makers),” Lipacis wrote.

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