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No. of Recommendations: 36
Warning, VERY long post ahead!

Since I found myself with some free time over the past few weeks, I figured it would be as good a time as any
to due some research on one of the hottest stocks over the past year, Broadcom Corporation (BRCM). This
company has gotten some notice hear on the Rule Maker boards in the past, scoring very well in previous Rule
Maker Ranker analyses. If you care to take a gander at these posts, check out the following links:

In any event, I figured I'd start from scratch since I really wasn't overly familiar with what the company
does and why it has been in such demand in recent months.

Step #1) Find out what the company does and see if it shows any promise.

I wandered over to the the Hoovers website ( and checked out their Company
Capsule section to get a brief overview of what Broadcom does. This is what I found:

"Wherever, whenever computers talk to cars and telephones talk to coffee makers, look for Broadcom at
the center of the action. The company develops integrated circuits (ICs) used in broadband data and
video transmission products. Broadcom's ICs are in more than 80% of all cable modems and digital set-top
boxes. They are also used in Ethernet networking, digital broadcast satellite, and digital subscriber
line products. General Instrument (now part of Motorola) and 3Com account for 38% and 28% of sales,
respectively. Founders (and billionaires) Henry Nicholas (co-chairman, president, and CEO) and Henry
Samueli (co-chairman, VP, and chief technical officer) each own 17% of the company."

Mmmm ... broadband! That explains the run-up, since stocks in this industry have been the Wall Street
darlings of late. As more people get connected to the Internet each day, the thirst for ever-increasing
bandwidth gets larger and larger, which means more demand for broadband equipment. So I'd say this
company passes my first screen ... being involved in an industry with a bright future.

Step #2) Find out exactly what the company produces.

As Rob Landley pointed out in his articles on LinuxOne, not all Linux vendors are created equal.
Just because a company is in the broadband market doesn't mean that it necessarily is a good company.
So, I took a look at their SEC filings over on the FreeEdgar website (, to see what the
company had to say about its products and markets. In regards to the markets it competes it, I found this
quote in its 10-Q filing from 1999Q3:

"Using proprietary technologies and advanced design methodologies, we design, develop and supply
integrated circuits for a number of the most significant broadband communications markets,
including the markets for cable set-top boxes, cable modems, high-speed office networks, home networking,
direct broadcast satellite and terrestrial digital broadcast, and digital subscriber lines."

Now, as for the products that it actually makes for each of those markets, I found this gem in its 1998
Annual Report:

"Our five primary product lines encompass:

1) high-speed communications and MPEG video/audio/graphics devices for the cable television set-top box market
2) high-speed data transmission and media access control devices for the cable modem market
3) 10/100/1000Base-T Ethernet transceivers, integrated repeater controllers, integrated switch
controllers and proprietary application specific integrated circuits ("ASICs") for the high-speed
networking market
4) receivers and MPEG video/audio/graphics devices for the DBS and terrestrial digital broadcast markets
5) broadband transceivers for the xDSL market."

If you want more detail about what all this technology lingo means, then feel free to read this whole section
of the Annual Report. It gives a brief description about the current state of each of the five markets
that Broadcom competes in (cable set-top boxes, cable modems, high speed networking, DBS and terrestrial
digital broadcast, and DSL) as well as significant detail about each of Broadcom's products in those
areas. Suffice it to say, Broadcom pretty much has the whole broadband industry covered with its product
line, regardless of which access method becomes the standard of choice.

Step #3) Identify the company's competitors.

Looking back at the Hoover's website, it lists the following companies as competitors:

Conexant (CNXT)
Lucent (LU)
Texas Instruments (TXN)

Rather than blindly take this list as golden, I went back to the annual report for Broadcom. Looking near
the end of the Business section, I found the Competition section in which it details who it views
as its competition. The list was pretty lengthy since Broadcom competes in so many different markets, but
the following names seemed to jump out in several of their product areas:

Conexant (CNXT)
LSI Logic (LSI)
Lucent (LU)
Motorola (MOT)
STMicroelectronics (STM)
Texas Instruments (TXN)

Because CNXT and LSI compete is so many different arenas with Broadcom, they were automatic selections.
LU and TXN are much larger competitors than Broadcom, so I thought it would be good to include them in the
analysis as well to see how Broadcom fares against "the big guys".

Step #4) Run Broadcom through the Rule Maker Ranker to see how it stacks up.

Financial AnalysiCompany Being Evaluated Competitor #1 Competitor #2 Competitor #3 Competitor #4

Broadcom Corporation Conexant LSI Logic Lucent TechnolTexas Instruments
Current PeriodYear-ago PerioYear-over-Year Current Period Current PeriodCurrent PeriodCurrent Period
1999Q4 1998Q4 Growth 2000Q1 1999Q4 1999Q4 1999Q4
Income Statement . . .
Sales 160,823 74,618 115.5% 509,963 584,856 10,575,000 2,554,000
Cost of Goods S 65,775 30,995 112.2% 277,446 344,770 5,706,000 1,308,000
Net Income 36,870 8,014 360.1% 53,318 76,413 972,000 433,000
Shares Outstand 120,563 108,626 11.0%

Balance Sheet . . .
Cash & Equivale 260,181 106,855 143.5% 277,516 661,300 1,816,000 2,662,000
Current Assets 391,327 172,644 126.7% 932,462 1,288,300 21,931,000 6,055,000
Short-term Debt 508 7,252 -93.0% 0 57,000 2,864,000 313,000
Current Liabili 86,062 40,978 110.0% 354,663 475,300 11,778,000 2,628,000
Long-term Debt 548 4,100 -86.6% 350,000 869,300 4,162,000 1,097,000
1 1 1 1
Margins & Ratios . . . Competitors' Avera
Gross Margins 59.1% 58.5% 0.6 45.6% 41.1% 46.0% 48.8% 45.4%
Net Margins 22.9% 10.7% 12.2 10.5% 13.1% 9.2% 17.0% 12.4%
Cash-to-Debt 246.38 9.41 2517.5% 0.79 0.71 0.26 1.89 0.56
Net Cash 259125.0 95503.0 171.3% -72484.0 -265000.0 -5210000.0 1252000.0-1073871.0
Fool Flow Ratio 1.53 1.95 -21.4% 1.85 1.50 2.26 1.47 1.77

Continue Here

Ranking Rule Makers

1) Brand Points (0-1) 3) Financial Dire Points (0-3)
Familiarity 0 Sales Growth 3
Openness 1 Gross Margins 3
Optimism 1 Net Margins 3
Legitimacy 1 Shares Outstandin 0
Inevitability 1 Cash-to-Debt 2
Solitariness 0 Fool Flow Ratio 3
Humor 1 Expansion Potenti 3
Subtotal 5 Subtotal 17

2) Financial Loca Points (0-2) 4) Monopoly Statu Points (0-4)
Mass Market Habit 1 Gross Margins 4
Gross Margins 1 Net Margins 4
Net Margins 2 Net Cash 4
Cash-to-Debt 2 Fool Flow Ratio 2
Fool Flow Ratio 0 Convenience 2
Your Interest 2 Subtotal 16
Subtotal 8
5) Your Enjoymen 1

Total Score 47 Second Tier

All in all, not a bad score considering its competition. Looking at the numbers, it is easily
possible for them to pick up a few additional points:

1) They just missed an additional point for gross margins (59.1% vs. 60% threshold)

2) If their flow ratio continues to drop like it did this past quarter, then they should be able to pickup
an additional four points in those categories.

3) You could argue that they deserve the point for familiarity, but since broadband access in all of its
forms is still in its infancy, I didn't feel right "giving" them the point at this time.

4) Their debt load has dropped tremendously, and it would be very easy for them to eliminate all the short-
term and long-term debt in the next quarter, thus giving them another point.

Just looking at the scores under financial direction, its no wonder this company has so many admirers.
Rapid sales growth, increasing margins, lower debt, and dropping flowie ... it just doesn't get any better
than this.

Step #5) Run Broadcom through our new financial metrics, the Cash King Margin and the Operation Cash
Net Margin, to see if it stacks up as a Rule Maker.

Year Cash King Margin OCNM

1997 -2557 / 36955 = -6.92% (-2557-7132) / 36955 = -26.22%
1998 8386 / 203095 = 4.13% (8383-27341) / 203095 = -9.30%
*1999 28569 / 357360 = 7.99% (28569-21479) / 357360 = 1.98%

* - figures as of the end of third quarter.

Well, unfortunately the results weren't as good here. Much like JDSU, Broadcom's margins in these two areas
are all over the map, but since there sales started exploding in 1997, the figures are gradually
improving. They still haven't reached our Rule Maker requirements of 15% Cash King Margin and greater OCNM
than Net Margin, so they still have some work to do in this arena.

When I dug a little deeper into the numbers to find out why Broadcom isn't generating a lot of extra cash,
I found a couple of things. One, the amount of Deferred Taxes that show up under Current Assets has
really skyrocketed over time. So what exactly are "deferred taxes" ??? Well, I put that question to our
account guru, TMFGrape, and he indicated that they represent tax benefits that can be claimed at some
time in the future. These benefits can be a result of operating losses, inventory that has been written off,
or cash reserves for a future expense that hasn't been incurred. In Broadcom's case, it is difficult to determine exactly where its deferred taxes come from
since that data only appears in the Annual Report (which is due out in about a month). However, from
digging through the 10-Q's over the past year, I would suspect that the large deferred tax burden comes from
the companies that Broadcom has acquired over the past year that were swimming in red ink … namely, Epigram,
Armedia, and Maverick Networks. Since "deferred taxes" shows up on the Asset side of the balance
sheet, it represents money that the company has already paid and doesn't have access to at the moment,
and thusly will appear as a negative value on the Cash Flow statement. To illustrate how this value has
grown over time, consider the following chart:

Year Net Income Defered Taxes Net Cash From Ops
1997 -1173 -571 -2557
1998 36398 -10443 8386
*1999 46417 -55143 28569

* - figures as of the end of third quarter.

I initially considered "deferred taxes" as a positive for the company, since it in effect represents tax
payments that the company will be able to deduct or write off at some time in the future. However, after
talking it over with our resident CPA "goo-roo", TMFGrape, I see that this category is actually a negative. Yes, the company will get this money back
in the future, but due to the effects of inflation, the amount we get back will be worth less than we
initially paid. When you add this to the fact that we can't use the money for any other purposes (like
investing in other companies, building a new factory, or paying for a merger or acquisition) during this
time period, then it really makes this payment a big fat negative. Therefore, I think this is something we
should watch carefully in the future in how it affects Broadcom's ability to generate Free Cash Flow.

Second, as their sales growth has exploded, so has their Accounts Receivable and Inventory amounts on the
Balance Sheet. To get a handle on these amounts, I calculated the Flow Ratio, Days Sales Outstanding
(DSO), Days Inventory Outstanding (DIO), Days Payable Outstanding (DPO), and Cash Conversion Cycle (CCC)
amounts for each of the past three years. The results are in the table below:

1997 1.57 96.6 65.2 178.0 -16.2
1998 2.23 65.4 30.1 80.6 14.9
1999 1.53 63.5 32.9 77.0 19.4

The flow ratio seems to be slowly trending downward, as are the Days Sales Outstanding and Days Inventory
Outstanding. This is a good sign in my book, especially given the dramatic rise in revenues over
the past two years (over 100% per year). The only disturbing thing is that the Days Payable Outstanding
seems to be decreasing at a faster rate, thus lengthening our Cash Conversion Cycle. Just in case
you have fogotten, the CCC represents "the number of days it takes a company to purchase a raw material,
convert it into a finished good, sell the finished good to a customer and receive payment from that
customer for that product … The lower a company's CCC, the better" (This quote was taken from TMFGrape's
excellent discussion of the Cash Conversion Cycle at
This rise in the CCC isn't that dramatic, but it is worth keeping an eye on in the future. I think that
it also partially explains why Broadcom isn't generating a lot of additional cash each quarter like
CSCO or INTC does.

Final Step) Determine if this stock passes my personal Rule Maker criteria.

At this point, I would have to say that the jury is still out on BRCM as a Rule Maker.

No, they currently don't meet the $1 billion annual sales requirement, although at their current rate of
growth they should surpass that figure in either 2000 or 2001.

Yes, they dominate the cable set-top box industry, but in their other markets they are surrounded by
competitors that are of much larger size (TXN, LU, MOT, CNXT, LSI) – this generally isn't the sign of a
true Rule Maker.

Yes, their financials look great, especially the gross and net margins, but they still have problems with
their Flow Ratio and other similar metrics. This is because they tend to pay off their suppliers faster
than they receive payment from their customers, which puts a drag on their Flowie, Cash King Margin, and
OCNM. Once they exit their current state of hypergrowth, these figures should settle down to more
reasonable levels.

In reality, I think Broadcom is probably more of a Mini-Maker at this point (for a complete discussion of
what a Mini-Maker is, check out TMFZeke's article at
Just doing a quick run-through of Zeke's checklist, Broadcom passes all but one of the nine criteria …
it's Flow Ratio is above the 1.25 threshold. Being a Mini-Maker isn't a bad thing – they often times
produce just as good returns as our traditional Rule Makers.

In conclusion, I have to say that I am quite impressed with Broadcom's current market position and future
potential. I think in time it has a very good chance of evolving into a full-fledged Rule Maker in the
broadband industry. There are some things that bear watching in the future (like its Flowie, Cash King
Margin, and OCNM), but I think its potential far outweighs its few warts.

Fool On!

The LanceMan

DISCLOSURE: As a result of doing this analysis, I have recently become a Broadcom shareholder.
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