Rivals Pose Challenge to Reign of Broadcom

The stock market may have overreacted by dumping shares of Broadcom Corp. last week after a competitor picked up a contract with Broadcom’s biggest customer. But the one-day, 17% stock price drop raises an issue once unthinkable by the Newport Beach chip maker known for its aggressive marketing and management styles: Is Broadcom losing its edge?

Starting with an explosive stock offering four years ago, Broadcom rocketed to prominence with an acquisition spree and an overwhelming dominance of the chip market for cable modems and cable set-top boxes, which it was the first to build. But as it enters new markets, it is finding competitors already there--even as its hold on core areas is being challenged.

“Broadcom is facing more competition on more fronts,” said analyst Jeremy Lopez at Morningstar Inc. in Chicago. “I am concerned in the longer term about their competitiveness. I’m a bit skeptical that they’re not going to hit a bump in the road. It’s got to happen some time.”

The contract that Texas Instruments Inc. won last week from Motorola Inc. probably will knock a few points off Broadcom’s sales to Motorola, which accounted for 14% of the chip maker’s sales last quarter. But Broadcom will remain the chip vendor for set-top boxes and the primary supplier of silicon for cable modems at Motorola, the world’s biggest cable-modem seller and a Broadcom investor.

“The [Texas Instruments] contract is a wake-up call to Broadcom that the market has matured and that it isn’t the only kid on the block anymore,” said analyst Jeremey Donovan at research firm Gartner Inc.

Though cautious, analysts know that the management machine that made Broadcom the fastest-growing chip maker in history is launching a slew of new products in eight new markets over the next two years.

“Better product, lower price and faster to market--that’s the tool that got us where we are today and will keep us going in the future,” said Chief Executive Henry T. Nicholas III. “We’re not just in all these markets, we’re an innovator in all of them. When I look at my competitive landscape, it’s actually less competitive now than it was before.”

If Broadcom continues to put more features on a chip and combine more functions in a product--effectively lowering prices and consuming less power--it will become the powerhouse of communication chips, analysts said. It already is a contender.

“Broadcom has been very dominant and is always going to face new competition,” said James Liang, an analyst at Pacific Growth Equities in San Francisco. “Though it’s facing competitive pressures in its core markets, it is well positioned in new markets.”

Broadcom doesn’t disclose publicly its share of the various markets it supplies. The overall market for communications chips was about $37 billion last year, and silicon for cable modems and set-top boxes amounted to 25% of the total, according to Gartner’s Dataquest unit. The research firm estimates that overall sales will slip a bit this year and grow 24% next year.

In interviews and analyst meetings, however, Broadcom executives give some hints about what goes into revenue that reached $1.1 billion in 2000--before the industry’s steep slide last year.

Nicholas, for instance, said Broadcom controls 70% of the silicon content in the $1.3-billion cable modem market, though many analysts estimate that the percentage is higher. Last week, William J. Ruehle, the company’s chief financial officer, told a group of analysts that more than 90% of the company’s revenue comes from four areas: cable modems, digital set-top boxes, servers and enterprise networks, which move data along corporate computer systems.

“All we do is broadband [high-speed connections], but within broadband, we do a broader scope of things than anyone out there,” Ruehle said.

The company’s stock typically has been pricey compared with others in the industry, whether it was $274 in August 2000 or in the $50 range in early January. But the beating that tech stocks have taken has pushed Broadcom’s value down 40% this year to $24.54 a share at Friday’s close on Nasdaq.

Since the company began operations in 1991, it has focused on developing high-speed semiconductors, adding more functions to them, integrating them into more products and selling them at a cheaper price.

The idea is to create networks of communication devices that meld voice, video and data into a seamless cycle.

Broadcom entered the set-top box market in the mid-1990s as the market was moving from analog to digital. Its first chip was a switch to change transmission from one to the other. It then built on that to develop chips to handle all the other functions.

In a recently announced deal, its semiconductors will be powering Motorola’s latest cable modem, one with a small antenna that provides wireless local area networking, or LAN. That’s the technology that lets consumers connect computers, phones, televisions--almost any communication device in the home--without additional wires. The technology uses existing telephone and electrical lines.

Some analysts, though, question whether consumers in a soft market for electronic gadgets will pay for a high-end home networking system that includes such features as private video recording, firewall protection, parental controls and virtual private networking connections.

“End-market demand concerns continue to worry us,” analyst Mark Edelstone wrote in a recent Morgan Stanley research report.

Nicholas, however, sees demand growing--at least for his company’s products.

“Ultimately, Broadcom is very confident in its broadband products,” said analyst N. Quinn Bolton at CIBC World Markets in New York. “They have the best integration, and they can apply the same marketing and product strategy to new markets where Broadcom starts from zero.”

Others, for instance, had developed Ethernet technology, which is a mode of communications across corporate business networks, long before Broadcom came on the scene in the mid-1990s. In an Ethernet product, one chip receives incoming data and figures out what all those ones and zeros mean. Another switch puts that information into packets, and a third switch figures out where to ship it.

Broadcom combined those functions and added more ports for connections on one chip, which cost more than a single chip but far less than the three that were needed. It ended up with a huge market share, said analyst Mark Grossman of S.G. Cowen Securities in Boston.

Marvell Technology Group Ltd. in Bermuda, however, has been grabbing some of Broadcom’s customers for the gigabit Ethernet, the fastest version that only Broadcom had produced.

“So we’ve got Marvell boasting that it has 5% of the market and we’ve gone to 95%,” Nicholas said. “But we’re not losing ground because demand is stronger. We’re going from shipping 1 million units last year to shipping 5 million this year.”

The company that gets to market first with a better product at a lower price can usually enjoy a near monopoly for a year or two until other firms catch up and compete better, analysts said.

“It gets to the point where there’s relatively little difference in the product, and you’re fighting a battle that has less to do with product and more with price and relationships,” Donovan said.

Nicholas said his company expects to face competition because all of its products are based on industry standards, which it helps develop and which others use to build their products.

Acquisitions have helped immensely, analysts noted. Over a two-year period, Broadcom acquired 20 companies, most with no products but with hot technology.

“When things were booming, all communications chip companies made lots of acquisitions, and the prices paid were outrageous,” Grossman said. “A lot of them didn’t work out, and they shut down some of those divisions. But Broadcom has done a reasonably good job in getting technology.”

By far, its best acquisition has been ServerWorks Inc., which it bought in January 2001 for 11 million shares of stock, then worth about $1.3 billion. Liang said the unit, which makes circuits for computers that act as Web servers, already had products and profit and is a “very strong growth driver” for Broadcom.

Over the next two years, Broadcom expects to burst into such fields as wireless and wireless LAN, direct broadcast satellite, voice over the Internet and the latest version of digital subscriber lines, or DSL. Those plans may give competitors reason to worry, Bolton said.

“Increasingly, as we go out and talk to competitors, whether they compete now or think they may in the future, when we ask them what name keeps them up at night, more and more the answer coming back is Broadcom,” Bolton said. “I’ve heard that from customers in different market segments. They look at Broadcom as a big, hungry company that can throw a lot of resources into anything they do.”

Broadcom also has been reducing its reliance on only a handful of customers. Cisco Systems Inc., which accounted for 14% of Broadcom’s revenue in 2000, signaled the start of the industry’s plunge in late 2000 when it disclosed that a huge inventory backlog and slack demand would cause it to cut back drastically on orders for chips from Broadcom and others.

Cisco had been the second-largest Broadcom customer behind Motorola, which accounted for 18% of Broadcom’s sales last year and 23% the previous year. Overall, Broadcom cut its reliance on its five biggest customers, which accounted for 49% of sales last year compared with 62% the prior year.

More important for Broadcom, though, is that its customers are showing their own financial health and reliability. Company executives said their customers are paying their bills quickly, now within 28 days of shipment, on average.

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