Summary
Broadcom Inc. recovered almost 5% yesterday, as dip buyers realized that the market might have been wrong in selling off AVGO.
Broadcom is well poised to benefit from increased focus on custom AI compute as big tech shifts more into inference.
DeepSeek's incredible achievements in lowering the hurdle for cost-efficient AI models could drive share gains for Broadcom.
Meta highlighted that it will invest more in its custom MTIA chips for inference before broadening to training workloads.
I argue why AVGO stock could be the ultimate beneficiary as hyperscalers tweak their plans to focus on more cost-effective custom AI chips.
I am JR research, an opportunistic investor who identifies attractive risk/reward opportunities supported by robust price action to potentially generate alpha well above the S&P 500. I run the investing group Ultimate Growth Investing.
Broadcom offices in Silicon Valley
What a week for semiconductor investors, as DeepSeek (DEEPSEEK) threatened to send us “into the unknown,” even though the models that it unveiled have already been in the “market” since Christmas. American AI companies and chipmakers probably tried to play it “cool” as there wasn’t a lot of hustle and bustle going on about DeepSeek until the record one-day swing in Nvidia (NVDA) stock this Monday.
Questions about the implications of DeepSeek’s incredible progress through its open weight release (not truly open source) were flagged by Stratechery’s Ben Thompson on January 21. They were already in in-depth discussion in the AI world, as Tesla’s (TSLA) former AI director Andrej Karpathy alluded to, while Nvidia’s senior research manager Jim Fan also pointed to in his posts.
Of course, we all know what took place just before January 21, as the world likely was too focused on President Trump’s inauguration and his first “100 hours.” The “avalanche” of activities included a media blitz and the signing of a deluge of executive orders, as the Trump administration attempts to shake up the old order (left by Biden). He was modeling new ones to fulfill his campaign promises (while not having to worry about reelection), as Trump seeks to “Make America (truly) Great Again” on his second and final term.
As for Broadcom Inc. (NASDAQ:AVGO), I believe the opportunity couldn’t have come at a more appropriate moment. While it certainly also felt the knee-jerk reaction on Monday, the stock gained 4.5% during Thursday's session as I write this update, and it has recovered 10% from its lows this week. However, amid the confusion in the market caused by DeepSeek’s revelations, I believe investors are right to be cautious, but there’s no need to “freak out” still…particularly on a semiconductor bellwether of the quality of Broadcom. Recall in my previous update that I indicated hyperscalers are increasingly looking to build their custom chips business, as they seek to hedge their exposure against Nvidia.
And with DeepSeek’s breakthrough this week, the stage is set for Broadcom to possibly win even more business from big tech. Why? Now remember that Broadcom has a well diversified portfolio that spans a range of semiconductor solutions and also software. However, its AI portfolio has gained even more credence, particularly in the networking and custom AI chips opportunities.
And these custom chips are likely going to play an increasingly pivotal role as AI scaling progresses from pretraining to test time compute. Hence, inference will likely see a sharper growth inflection in spending on AI compute. That thesis has been corroborated by one of Broadcom’s main customers, and you probably know who, as this customer just released its earnings on Wednesday evening: Meta (META). Let’s hear it from Meta CFO Susan Li at her company’s earnings call:
Finally, we’re pursuing cost efficiencies by deploying our custom MTIA silicon in areas where we can achieve a lower cost of compute by optimizing the chip to our unique workloads. In 2024 we started deploying MTIA to our ranking and recommendation inference workloads for ads and organic content. We expect to further ramp adoption of MTIA for these use cases throughout 2025 before extending our custom silicon efforts to training workloads for ranking and recommendations next year. - (Meta Q4FY2024 earnings call.)
Did you manage to catch “custom MTIA silicon in areas where we can achieve a lower cost of compute?” While MTIA certainly isn’t new, I believe the war rooms set up by Meta this week has likely jolted the company into action. It seeks to regain traction with enterprise customers and application developers who might be (or considering) migrating to DeepSeek’s model, while eschewing Meta’s large language models, or LLMs. Unless you have not been reading up about DeepSeek, we are likely all aware that the China-based AI firm has scored top accolades for its ability to achieve significant improvements in cost efficiencies through its algo innovation. It has impressed the AI community so much that requests to use DeepSeek’s models have gained traction, such as even Microsoft (MSFT) has decided to host it in Azure.
Therefore, while Meta and its LLM peers will no doubt seek to build even more AI compute on the training front, MTIA will likely feature heavily in its upgraded CapEx outlook of up to $65B this year. Meta isn’t shying away as it underscores its intention to “further ramp adoption of MTIA,” and even alluded to using its custom silicon for training workloads as well.
Therefore, that brings us back to Broadcom’s AI revenue SAM outlook of between $60B and $90B, with a midpoint of $75B. I believe the market is likely seeing a higher potential of Broadcom moving closer to the top end of its guidance range. This could drive even more upgrades, as the company has already pointed to “two (new) undisclosed customers” in December, with OpenAI potentially being one of them.
An October report suggesting that OpenAI has been working on such a custom AI chip with Broadcom corroborates the view that I’ve presented. While Nvidia might continue to feature heavily in OpenAI’s highly ambitious $500B Stargate partnership venture, I believe the upside bias of including more of AVGO can no longer be understated. This is even though the company has yet to be included in the list of main technology partners, as indicated in OpenAI’s press release. However, if you read its press release carefully, the company indicated that “Arm, Microsoft, Nvidia, Oracle, and OpenAI are the key initial technology partners.” Incidentally, the key word here is none other than “initial.” Will Broadcom feature? I think the market’s positive reaction based on today’s surge likely sees AVGO playing not just a key role in Meta’s upgraded CapEx spending, but also the potential opening with OpenAI. This might not have been fully contemplated into Broadcom’s prognosis when it first presented its game plan in December last year.
Broadcom estimates
Now, I don’t think Broadcom will change or upgrade its SAM opportunity anytime soon, although I believe it does clarify the company’s revenue trajectory better past FY2025. After accounting for VMware’s acquisition, AVGO’s revenue growth rates should normalize through FY2026, even though it’s still markedly above the five-year average of 12.5%.
I think uncertainties pertaining to the near term growth impact from Meta and OpenAI could persist, although Meta has made it clear that the inference ramp up is for 2025, which should benefit Broadcom. Hence, I believe the market is likely betting that CEO Hock Tan and his team could telegraph a clearer outlook toward achieving the upper boundary of Broadcom’s updated outlook. There is a possibility of an even more optimistic guidance if we can have better clarity into Stargate’s long-term plans. However, I think that remains a growth optionality for now. The developments are still too nascent for us to consider the accretion, particularly as the venture has yet to list AVGO as one of the main tech partners.
AVGO price chart (weekly, medium-term, adjusted for dividends)
While the DeepSeek fallout did see AVGO take a tumble this week, I’ve also assessed a possible bullish reversal signal while writing this update, auguring well for buying the dips aggressively. AVGO has already dropped more than 20% from its December highs through its lows this week, placing the stock briefly in bear market territory, although dip buyers have capitalized.
I don't expect hyperscalers to pull back from their plans of investing more aggressively into custom AI compute. They probably might even allocate more spending to Broadcom’s AI chips, as they seek to lower their costs in their bid to improve their cost efficiencies further. Moreover, Broadcom’s well diversified portfolio should help to mitigate the uncertainties from DeepSeek, and help investors to lower their volatility risks as compared to the higher AI revenue concentration in Nvidia’s business segments.
AVGO’s forward EBITDA multiple of 26.6x is in line with Nvidia’s 26.4x metric. So, the market has clearly upgraded their outlook on Broadcom’s prospects, likely seeing the semiconductor leader as a credible contender to stake its claim as the second horse in the race against Nvidia’s stranglehold on merchant AI chips. Despite that, AVGO’s PEG ratio of 1.5 suggests the stock isn’t overvalued when we juxtapose it against its tech sector peer's median of 1.81 (17% discount). Therefore, I believe it is reasonable for me to maintain my optimism in the stock, notwithstanding the slew of uncertainties linked to DeepSeek’s morass.
Investors who feared the worst and took their positions off on Monday are likely regretting the move now, as data center operators have shown little inclination to lower their penchant for AI compute. Instead, it has likely strengthened their resolve to find more opportunities to level up their efficiencies across the value chain, and Broadcom offers a tremendous opportunity to do so. Coupled with its relatively attractive valuation, I see the potential bullish reversal in AVGO as offering investors another timely opportunity to gain more exposure to a high-quality semiconductor leader.
Rating: Maintain Buy.
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