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Broadcom: Wall Street Focused on Turnaround

After deliberating for five and a half days, a jury last month convicted the former chief executive of San Jose’s Brocade Communications Systems Inc. of falsifying stock options.

The next morning, the networking gear maker’s stock surged.

Wall Street paid more heed to Brocade upping its quarterly profit forecast than the jury’s decision. Investors drove the shares up 12% on the strong outlook, which came just hours after the conviction.

Brocade’s experience probably didn’t go unnoticed at Irvine’s Broadcom Corp.

The chipmaker earlier this year posted the biggest bill,$2.2 billion,of any company involved in the options backdating issue.

The two cases have similarities.

Both are technology companies that saw big charges to restate past results to fix backdated options. Both saw their chief financial officers resign amid options probes. And, in both cases, former chief executives became the focus of federal criminal probes.

At Broadcom, cofounder and ex-chief executive Henry Nicholas is the focus of a probe by an assistant U.S. Attorney in Santa Ana.

The investigation has taken salacious turns, unearthing allegations of drug use and other unseemly behavior by Nicholas, who left the company in early 2003.

But, as with Brocade, Wall Street doesn’t seem troubled by the Nicholas sideshow. As of last week, Broadcom’s shares were flat for the year,not from options fallout but due to a lingering slump in the chip sector.

In mid-July, when Nicholas was the subject of a series of unflattering stories, Broadcom’s shares actually enjoyed a runup.

Analysts are aware of the Nicholas issues, but they don’t factor into their assessments of Broadcom, they say.

“To be honest, it hasn’t come up in my conversations with investors,” said Ruben Roy, an analyst at Pacific Crest Securities in Portland, Ore.

Wall Street seems to regard the issue as a lingering historical matter that doesn’t stand to impact Broadcom’s sales of chips for wireless phones, computers, networking gear and consumer electronics.

“The main concerns (about options) are in the past now,” said Ross Seymore, an analyst at Deutsche Bank Securities Inc. in San Francisco. “Most of the management team has been exonerated.”

Broadcom’s own report on options backdating earlier this year said Nicholas “bears significant responsibility for the lack of adequate controls in the option granting process due to the tone and style of doing business he set.”

The report also said there was “substantial evidence” former chief financial officer Bill Ruehle was involved in backdating. Ruehle stepped down a year ago.

The issue predates Chief Executive Scott McGregor, who joined in early 2005.

Henry Samueli, who cofounded Broadcom with Nicholas and is chairman and chief technology officer, served on the board committee that granted and issued stock options with Nicholas.

But Broadcom’s report didn’t lay blame with Samueli, saying he “reasonably relied on management and other professionals.”

Analysts are hesitant to speculate at what point a possible indictment, trial or plea involving former executives would impact Broadcom’s stock, if at all.

One potential concern is if a criminal case touches on current employees or practices at Broadcom, Pacific Crest’s Roy said.

That includes Samueli.

“Henry Samueli is the last executive standing that’s part of the old Broadcom,” Roy said. “He’s the visionary behind Broadcom. The only way this turns into a material negative for the company is if he is removed from his post.”

Earlier this year, Samueli did decline an informal request for an interview by federal criminal investigators. At issue was whether they wanted to talk to him as a witness or as a subject of the investigation.

But there’s no recent indication federal criminal investigators are focusing on Samueli.

Samueli could be named in a civil lawsuit over options by the Securities and Exchange Commission. In July, the company was given notice by the SEC of a likely suit. But that didn’t seem to worry investors.

A more pressing concern for Wall Street is the lingering chip slump that has crimped Broadcom’s growth for the past year or so.

“Broadcom hit a soft patch in the second half of 2006,” said Larry Cao, an analyst with Morningstar Inc. in Chicago. “The issues are temporary and not structural.”

Broadcom has weathered the slowdown better than some other chipmakers. But some company watchers are getting anxious to see more signs of a rebound.

“They didn’t fall as hard as others but they haven’t snapped back as quickly, either,” Deutsche Bank’s Seymore said. “It’s been a bit of a frustrating wait.”

Analysts expect gains by the end of the year.

An August contract with Nokia Corp. is set to boost revenue in the coming quarters, according to analysts.

“Several new growth drivers have now had time to bake,” said Allan Mishan of CIBC World Markets Corp.

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