Key Points
Broadcom's reliance on the growth of prominent AI start-ups represents an underappreciated risk, according to one Wall Street analyst.
Anthropic and OpenAI can't yet pay their own way, and the analyst suggests this will take time.
That risk is already baked into Broadcom's valuation.
Shares of Broadcom (NASDAQ:AVGO) turned lower on Friday, falling as much as 7.3%. As of 12:53 p.m. ET, the stock was still down 5.1%.
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The catalyst that sent the semiconductor and networking specialist lower was a downgrade and bearish commentary by a Wall Street analyst.
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Pay their own way
Rothschild & Co Redburn Mike Harrison downgraded Broadcom to neutral (hold) while simultaneously reducing his price target to $398 from $595. That represents potential upside of just 9% compared to Thursday's closing price.
The analyst takes issue with Broadcom's customer concentration and increasing reliance on artificial intelligence (AI) start-ups OpenAI and Anthropic. He goes on to say that Broadcom's growth will ultimately depend on the two AI start-ups becoming self-reliant. Anthropic and OpenAI "need to establish sustained primacy over open models and become self-financing in short order ... clearing these hurdles is appreciable but is unlikely to occur quickly."
The analyst may have a point. While Broadcom's application-specific integrated circuits (ASICs) -- also called XPUs -- are in high demand, the company is backstopping financing for some of its biggest customers. OpenAI is currently Broadcom's second-largest custom chip customer, and Anthropic is expected to surpass Alphabet as the largest purchaser of XPUs by 2027.
Yet the devil's in the details. Broadcom has provided up to $63 billion in financing guarantees to help Anthropic buy its chips, while backstopping another $50 billion for OpenAI.
CEO Hock Tan laid out a compelling argument for guaranteeing financing deals for OpenAI and Anthropic. "It's a great investment for us when you think about it: every gigawatt of compute they deploy, they could achieve $30 billion of ARR [annual recurring revenue], annual revenue per gigawatt. That's a hell of a business model."
There's no question that Broadcom is taking on a degree of risk by guaranteeing these loans for OpenAI and Anthropic -- giving rise to concerns about circular financing.
That said, at less than 18 times forward earnings, that risk is already baked into Broadcom's stock price.
Danny Vena, CPA has positions in Broadcom. The Motley Fool has positions in and recommends Broadcom. The Motley Fool has a disclosure policy.