Broadcom Inc. (AVGO) Earnings Call Transcript

Good morning, everybody, and welcome to the second day of the Deutsche Bank Technology Conference, of course, being held virtually this year. Our next keynote speaker we're very thrilled to have here with us is Hock Tan, the President and CEO of Broadcom.

Hock, before I get into some more Broadcom specific questions, you've been around this industry for many times. You've seen a lot of structural changes in it. So I wanted to ask you about some bigger picture questions. So first, as we are just talking about in the ready room, during this work-from-home, COVID pandemic, there's been a lot of changes, some things structural and some things temporary. Talk about how Broadcom has adjusted to this. And do you believe there's some structural changes happening at the company? Or do you think Broadcom can operate just as efficiently in a remote environment as it does when people can work together?

Well, good morning, Ross, and good to be here. Good to see you virtually. And we're happy to try to respond to that. Well, as you can see, I'm in my office. And speaking for Broadcom on this perspective, we were shut down, locked down like most businesses and most companies, I would say, if not all, in March. Then in late April, we started gradually building ourselves up in terms of back to the office. And today, starting July, we are now at about 50% workforce back at the office. And that's as far as we can go really at this point in North America because of social distancing requirements and various other things given our footprint. Having said that, there's obviously a reason why we brought back 50%. Because while in many areas, we can work from home, our workforce, the functions still operate very well working from home. And I dare say in many cases, even productivity is maintained. And I believe we saw that in some other situations, especially in large product development, we need collaboration, very close, constant collaboration between -- within teams of people. And for that -- and then for hardware, obviously, we need labs. We need the labs to run. We need validation. So we have worked very well, very carefully, given safety is of paramount consideration, safety of our employees and workplace, to slowly bring in people to work and collaborate for our engineering development. As far as the operating cycle, we're chugging along very nicely now. And in Asia, except for India, our employees are 100% back at work. North America, as I say, is 50%. As far as structural changes, sure, on the demand side, we have seen quite a bit of change. And we kind of indicated that in our earnings call recently. What we're seeing is very interesting. We put it in the context. As you know, Broadcom is especially on the hardware side, and it has -- which is 75% of its revenues currently. Basically doesn't do compute. It doesn't do general-purpose computing, doesn't do memory. But networking of connectivity, as we call it, we are pretty broadly based. We are in, I will consider, almost every critical product in connectivity today. A fairly broad range, something like 18 different product franchises for which our business model, we are leaders. And they are very -- they are in multiple end markets, as we have indicated many times, ranging from broadband networking to server storage, wireless and pretty much industrial as well. Those are the end markets. What we have not literally pushed -- indicated in the past is metrics across these end markets are who those products we sell going to. And roughly, we're talking about 30% of our hardware going to enterprise, traditional enterprise roughly, 25% cloud and telcos and about 20% going to the consumer. And these are our wireless business. Then, of course, there's 25% in software, infrastructure software. Now in this environment, demand environment, here is what's going on. 2019 was a recessionary year for semiconductors, well-known to the whole industry. Having said that, we see that as a cycle. We also see, as we emerge from fiscal 2019 or calendar for that matter, that the market, the tide was risen, the semiconductor. That part of the cycle where there is a recovery. So we put out a set of numbers for our fiscal '20 year as predicating a tide rising across the market and especially infrastructure, not to mention cloud and others, and showing a recovery. COVID-19 hit early part of 2020 and immediately saw sectors of demand of the economy shutting down. That's it. Things are uncertain. Things look bad. And what's very interesting is looking back now at the close -- quite the close of fiscal 2020, we're looking back and saying, lo and behold, a surprising turn of events and something I did not even would imagine early part of 2020 when we got hit with COVID-19, economy. What we've seen is on cloud, on broadband, telcos, a sharp increase, whereas on enterprise, in hindsight, we could see work-from-home environment, demand softened. Sectors of economy are closing down like travel and hospitality. And kind of looking back now, the 2 -- interestingly enough, we're able to offset each other. Now as far as our infrastructure software is concerned, again, these are 2 of the largest corporations in the world and they are on term contract. So they're just riding through this nicely. What's uncertain is obviously wireless consumer, and it's because the launch, where the biggest part of our customer base is, tends to be at year-end, is always at year-end seasonally. And obviously, we are seeing a delay in that. And therefore, our fiscal '20, which ends in October, do not see part of that. But on our -- the rest of our business, it was, quite interestingly, offsetting the other. What I'm trying to get at for Broadcom is we're pretty diversified there. Diversity drove into a very defensive model as it's done now because if you take out the wireless, the total set -- the numbers, top line numbers came in just above what we initially predicted except for totally different reasons. Now is this sort of thing permanent is what you're addressing. I don't know. What we see is obviously -- and what you see now then is that cloud -- a lot of people are working from home. A lot of companies have difficulty, obviously, bringing things back on-prem, in the offices. Enterprises cut back. So -- but a lot more -- the digital transformation, we see a big part of our economy, mostly to the cloud. And telcos provide the pipes to the homes, to various parts of it. So we see that much stronger, as we have reported, than we set it out to do. In some situations, we see sequential double-digit growth or high single-digit growth for the last 3 quarters. The question is will it be that way next year, which is, by the way, as far as I can imagine, I want to see. And the answer is don't know. But I can imagine a situation that if the vaccine shows up and we restore ourselves back to more pre-COVID-19 social environment, I can imagine that enterprise will pick up on pent-up demand just for that. But I can also see -- foresee in the same situation that cloud and broadband from telcos would cut back down. And we'll be back to where we originally thought we should be. But to be honest, at this point, I can't see beyond that point in 2021.

Well, if you can see all the way into 2021, your visibility is better than most of ours. So we appreciate your discussions on that. Maybe the last COVID-related one is specifically on the supply side of the equation. I know in your last 2 quarters, you had some issues, and then those issues got resolved. Are those now in large part behind Broadcom? So if your customer needs the supply, they can get it? Or are you still dealing with some longer lead times or production issues due to shelter in place, warehouse issues in different regions, et cetera?

No. The issues we had initially and when the pandemic hit, it's, in some ways, unique to partially us, though it's hit a lot of other businesses, too, which is the lockdown in certain countries, especially in Asia, where we have a significant part of supply chain, countries where there's substantial lockdown. And as a result, some of our back end, especially where there's testing, assembly testing or even our warehouse, would not -- are not -- were not able to operate at full capacity. These are countries in Asia like Malaysia, Singapore, Thailand, Philippines. They were hit. And initially even China. And that undercapacity production activity sort of constrained the supply chain. Those are all largely done and resolved. And the lesson we learned, which we started doing during the -- and have continued, diversify, as we have diversified our products, our end markets, diversified or create second sourcing for where we do critical parts of our supply chain. And we actively do that. So lesson learned is diversify the risk in countries, locations. Where supply chain is still constrained very strongly is more capacity, capacity as it relates to wafers, leading-edge wafers and capacity -- there is capacity constraint as there is capacity constraint on specific key components like substrates. That is still a real constraint on ability not just of us, I would say, of the industry to fulfill end demand in a manner we would all prefer to do.

I know you mentioned that dynamic on your last conference call as well. When do you think that gets resolved?

Well, some things, especially in capacity, I'm sure -- I'm pretty positive by '21, much of that would go away because there will be time for the system, for the supply chain for semiconductors to adjust. And I think by '21, it would be likely resolved by, if not early '21, mid-'21.

Great. Why don't we pivot to the second macro dynamic that's made 2020 an interesting year to put it mildly? And that is the U.S.-China trade dispute and trade tensions. There's a couple of aspects on that. Let's leave the M&A aside as a separate topic I'll get into afterwards. But as far as your ability to ship to certain customers, Chinese vendors being placed on the Entity List, how are you viewing that dynamic? And what impact, if any, has it had on Broadcom in the last year? And how do you think it's going to impact your business going forward?

Well, this interesting thing, I have to say, is it gets more headlines, frankly, than it probably, in some ways, for our business, from a business point of view for -- especially down to Broadcom, than it really deserts in many ways. Because at the end of the day, you're right, we have been living with this U.S.-China trade tensions and restriction for virtually 2 years, at least 18 months or 2 years. And so we have the benefit of looking back and seeing what it is, even though there's a sense that we should have -- we kind of would expect some of that. And here's why it is. First, the semiconductor industry is a global industry, been that way for 50 years, 5-0 years. Long time, over the years, built up common standards and all that. It's a very coupled ecosystem. And I put it bluntly, very tightly coupled, over 50 years of development. It doesn't decouple very -- any way quickly. It doesn't decouple in a year, in 6 months or something, not easily. And it's -- so it is very coupled, number one issue. Number two, we sell our products, our products, technology products. At the end of day, those are products, but those are most of the products we do, Broadcom, especially on the semiconductor side, all on the semiconductor, are basically technology. And these are technology serving end users, enterprises, consumers but end users at the end of the day. So what it really boils down to is simply this, and the best way is that we sell through channels. I call an OEM, original equipment manufacturer, be they like Huawei or anyone else on the Entity List. They are channels to the end user, the basic enterprise end user, be they in China or outside China. And if -- and the other perspective I want to give on Broadcom is, as you know, our products are all we consider critical important franchises. We don't try to do products that are not. We, in fact, avoid those. So to give you a perspective on where we stand, the whole semiconductor output worldwide, globally, China consumes over 30% today of its output. As a percent of our revenues, our sales to China, exposure to China indigenously, 13%, 1-3. What does that tell you? We don't sell commodity products. Whether they are substitutes, they've done that. So what this trade tension has done, obviously, and we've seen that for years, but what it's done the last couple of years, it probably tried to accelerate China in self-sufficiency in semiconductors. Something they would have done anyway given the size of the market, it would have done. Maybe this got accelerated. And obviously, the things they could do along are more commoditized products. The products that are less commoditized, which is kind of where our franchises are, they do not -- cannot be easily replaced. I'm not saying it will never be replaced. It will take a long-term for that to happen. Hence, that 13%, as I said, what's the 13%, in fact, a year ago, 2 years ago, hasn't changed that much. And what I'm trying to say is if people -- if -- and the end user in those economies would be -- they can't get it from one OEM. Another OEM would be picking up the slack. There will be, over a period of time, an adjustment. And we have seen that over the last 1.5 years of this U.S. trade tension. Short term, you're right. On a quarterly basis, you might see some dislocation. But over a period of 6 months, a year, especially in 2 years, these things will all settle down. Market share will shift. But if your products are required, are needed, are critical, then it will end up in the -- where the end-user needs it on a legitimate basis.

Thanks for that detailed answer. Let's go to the second aspect of some of the trade tensions, and the way that could apply itself to the semiconductor market and I guess even other markets would be in the regulatory approval for M&A. Obviously, Hock, you've been incredibly active on the M&A front, initially on the semiconductor side and then moving into the software side. Before we get into the Broadcom specific aspects of that, I wanted to get your views on the aggregate M&A environment right now, in the regulatory environment given that big M&A in big tech seems to have come back into vogue, especially just yesterday with a couple of gargantuan deals being announced. So how do you view the regulatory environment for those sorts of deals as you've had to go through big deals you attempted to do in the past and unfortunately got blocked at that time?

Yes. Learned the lesson big time there. Thank you. And the environment has gotten much more challenging than we have ever seen it, I think. And in today's environment, especially with the U.S.-China trade tension, with a very aggressive European Commission in terms of scrutinizing any deals, much less large tech deals, I would say then it's very, very challenging to try to make -- to do any tech acquisition and get it through regulatory approval in any fairly normal fashion. I'm not saying it can't be done. I'm pretty sure there are basis in some situations, but it will challenging and it will be lengthy and might be even painful in terms of mitigating conditions that are required. So that's my sense.

So when we pivot this to what it means for Broadcom specifically, do you think that your balance sheet is back in the position that you'll be playing offense on the M&A front as we look into 2021?

Well, you were nice to put some words in my mouth to say I have visibility on 2021. I was actually guessing what 2021 might look like, we have a vaccine and post-COVID-19, maybe we won't be. Right now, to be honest, we are looking at 2020, almost at the tail end, but we are obviously starting our process and looking hard at 2021. And there were some questions asked of our capital allocation. And it is inevitable because our M&A strategy, as you correctly pointed out, is also dependent on our financial capacity, our financial position in terms of being able to continue a cadence of a decent-sized acquisition once a year. And as -- at the risk of repeating myself, Ross, and since we have some 45 minutes, I'll jump in it, as you know, our business model is very simple and clear, okay? We have acquired -- and I don't want to use the word consolidate in the semiconductor industry or any industry. We acquired what we consider critical product lines, products within the semiconductor industry in the past and more recently software. We consider those mission-critical products performing important functions for end markets. We acquired those. And basically, we focus them. We then ensure that we optimize each of them. And by that, I mean, we put in the investment sufficiently and as much as we need, sustain each of those franchises. And those franchises, as I said, are in, we believe, sustainable markets. And we make sure we remain -- continue the leader in each of them. We do it across the board. And as I said, we have pretty much done it in semiconductors, in connectivity, not doing memory, not doing general-purpose computing, very clearly in connectivity. We have a whole set of businesses that we almost believe we have a full portfolio almost of those critical franchises in connectivity. And we do one at a cadence of on average once a year. So as far as '20 is concerned, with the COVID-19 and the uncertainty, we have pulled back on it. And right now, in '20, what we're focusing on doing, as we have done recently in the last 6 months or so, is shore up our financial position, one of which is we have a significant amount of debt, investment-grade debt, investment-grade position. And we are very, very clear about maintaining that position. So we have pushed out the maturities of those debt. And on average now, average 6-month -- 6 years maturity of our debt. In the next year or 2, virtually nothing comes due. That's one. And we did that several months ago as we refinanced in the debt market. That's very favorable. And we're able to do it, pushing them out from 3% a year. Anytime we'll do that. Then we focus also on the level of the debt. And last quarter, Q3, we paid down almost $2 billion of that debt. And this quarter, given the strength of our cash generation, we're going to pay down another $3 billion. Beyond that, that's what we're looking at very hard, which is looking at fiscal '21, which begins, obviously, November 1. One, we will preserve our dividends, no matter what. Question is, we have a policy, would we increase our dividend? That's something we're looking at. We don't have to tell you that for another 3 months when -- in the next earnings call, when we have clear visibility. So then we go answer your question before you ask that. But it also means that -- what does our financial position look like? Well, looking very good given the earnings we have reported in the last couple of quarters. We're generating a huge amount of cash. No travel. It's -- expenses are kind of down. And our demand is still there. And our margins are very, very good. So we're generating a lot of cash. And for '21, we have to consider what's our likely use of that cash. For one, for sure, dividends. And the other aspect of it is would we be in a position to stand the cadence of an annual acquisition beginning in '21. We're not sure yet because the other choice of the money -- of the cash we're accumulating is really -- other than, obviously, the dividend is, for sure, preserve. And the level of dividends we have to decide is we could pay down more debt and strengthen our balance sheet further, if there's uncertainty we continue to see in 2021, or continue on the cadence of a thoughtful acquisition of a manageable size on an annualized basis, continue in that model, right? And right now, the answer to that is we're not ready to give you an answer yet until 3 months from now.

I had to try. I'll try a few more aspects of that. So given the regulatory environment question that you answered before about it being more difficult, does that dictate the size of deals that you would try to acquire and pull off more so than it might have in the past?

Oh, yes. Oh, yes. Probably it has an influence on that. And because reality is what we call when you do a deal, as we have always thought through, we do actionable deals. We don't sell a must sell. We must want to -- we must want to buy it. That's the usual criteria, and that makes sense. And I said we're not consolidating. We're not buying for the sake of buying. We're buying because our business model is while we can grow our business base organically, both on top line and earnings profitability while we can still grow, we increase it from single-digit growth organically to double-digit growth through thoughtful acquisitions of the nature we want. And we figured we can do it in a reasonable fashion if you look at it this way. Right now, our EBITDA -- adjusted EBITDA is about $12 billion to $13 billion a year. If we buy -- make acquisitions around $5 billion to $10 billion and generate from it, typically, we generate double-digit cash-on-cash return. We would add a nice -- we will put in a nice contribution within that kind of acquisition to grow our bottom line EBITDA double digits when we combine with organic growth. And that's very much still our business -- our business model translating to a financial model, which is top line growth, mid-single digits organically and bottom line growth, high single digits organically with acquisitions on a total annual basis of a size of $5 billion to $10 billion. We would be able then push EBITDA growth to double digits on an annual cadence.