Tuesday, March 17, 2015

Avago Stock Is Worth the Risk

Stiff competition and troubling lawsuits aren’t likely to slow Avago stock's upward momentum

Avago Technologies AVGO stock
Avago Technologies Ltd (NASDAQ:AVGO) was recently hailed as the fastest-growing company in the Standard & Poor’s 500. A look at its stock performance confirms it’s doing a lot right. The Singapore-based chipmaker is currently trading around $125 per share, up more than 99% over the past year and an amazing 536% over the past five years.

Last year, Avago increased revenue more than 96% to $5 billion. The consensus on Wall Street is that AVGO will grow revenue another 60% in 2015 to reach $6.8 billion.

Avago’s revenues have grown at a breakneck pace thanks in part to last year’s acquisition of two major industry players, LSI Corp (NASDAQ:LSI) in May and PLX Technology Inc (NASDAQ:PLXT) in June. Shortly after it acquired LSI Corp, AVGO was added to the S&P 500 index (replacing LSI). Management stated that the acquisitions would allow the company to expand operations in the storage hardware and data center arenas.

Clearly, Avago stock is on a tear and Wall Street analysts have high expectations for the future. This, however, begs the question: Is there anything about AVGO that has the potential to threaten the company’s future growth potential?

It’s not uncommon for investors and analysts to downplay potential risk factors in the wake of overwhelmingly positive results. Is the overwhelmingly positive consensus influenced by Groupthink and the Bandwagon Effect?

Acquisition Lawsuits Involving AVGO

In Jan. 2014, a group of investors led by the City of Orlando Police Pension Fund filed a lawsuit against LSI, claiming that the acquisition agreement between AVGO and LSI resulted in an unfavorable outcome for stockholders. The suit claims that LSI’s board of directors’ approval of the $6.6 billion deal ($11.15 per share of LSI) violated their duty to shareholders because a provision in the agreement barred other potential buyers from making competing offers.

In June 2014, a similar suit was filed against AVGO regarding its acquisition of PLXT. Apparently, shareholders of PLX Technology also believed that the board failed to conduct business in a manner that most benefited stockholders.

Most recently, a group of Emulex Corporation (NYSE:ELX) investors has filed a lawsuit to put the brakes on the company’s acquisition by Avago Technologies. The claim is identical to the ones filed by LSI and PLXT shareholders. The plaintiffs believe that Emulex’s board has failed to adequately serve the interests of investors by agreeing to a $606 million offer from AVGO without considering possible alternative offers.

It’s no secret that lawyers are expensive and court cases take forever. If the courts rule in favor of the plaintiffs, Avago Technologies may be compelled to pay shareholders sums equal to their hypothetical profit losses. The combination of legal fees and potential settlement costs could cut into net profit figures for Avago stock.

Silicon Competition

According to IDC, approximately 500 million smartphones will be sold in China this year — that’s triple the number predicted for the U.S. and one-third of sales worldwide. China’s cellular evolution to 4G infrastructure is responsible for this anticipation. Consumers who want to utilize the 4G network will be required to purchase a compatible handset.

This fact has led Avago Technologies, as well as other mobile chipmakers such as Qualcomm, Inc. (NASDAQ:QCOM) and Marvell Technology Group Ltd. (NASDAQ:MRVL), to increase production of smartphone-related components for Chinese handset makers. Considering that AVGO supplies radio frequency chips for the Apple Inc. (NASDAQ:AAPL) iPhone and Samsung Elect Ltd (OTCMKTS:SSNLF) Galaxy series of smartphones, Avago stock will rise as a direct result of new smartphone sales in China.

However, with increasing competition from MediaTek and, most recently, Intel Corporation (NASDAQ:INTC), Avago might have a tougher time pushing its silicon. In the longer term, competition for Chinese market share will be further complicated by the government’s efforts to reduce dependence on foreign chipmakers. Within five to ten years, government-sponsored foundries and chip-making facilities will likely be responsible for the majority of smartphone silicon needed in the country. As the number of competitors increases, the availability of potential customers will continue to shrink.

Final Thoughts

Even as I raise some of the risks to Avago — things that could pose a real threat to AVGO’s future share price — I think the company is well-positioned for solid short- and medium-term growth.

The lawsuits aren’t much of a concern, considering AVGO has in excess of $1.6 billion in cash that could be used to satisfy unhappy shareholders. Competition from the likes of INTC isn’t worrisome because, even if Avago loses its Apple contract to Intel, revenue from domestic Chinese smartphone makers increased last year and is expected to continue increasing throughout 2015.

Additionally, AVGO silicon is responsible for a number of the new features in Samsung’s Galaxy S6, which should be available in early April. As Samsung’s premier flagship smartphone, the Galaxy S6 should see solid sales figures, further supporting Avago stock throughout 2015.

Article originally appeared on InvestorPlace (03/17/2015)

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