By Asa Fitch

Broadcom is making a lot of money by helping tech companies manufacture custom chips that speed up artificial-intelligence computations. Investors seem to be giving it too much credit for that.

Broadcom's stock is the fifth-best-performing in the S&P 500 over the past two months, rising more than 70% over the period -- a stunning rise given the company's already large size. It eclipsed a $1 trillion valuation on the way up, surpassing Walmart and Tesla, and becoming the seventh-most-valuable listed U.S. company.

A large measure of the excitement is justified. Years ago, Broadcom began helping Google make AI chips, an interesting but not wildly profitable side hustle at the time. The AI boom completely changed that. Alphabet's Google rushed to order more custom chips to infuse AI in its search engine, among other things. New customers, including Meta Platforms, lined up.

Broadcom now expects $5.1 billion of revenue from AI processing and networking chips in its current quarter, up 60% from a year before and roughly a third of overall projected sales. It delivered another set of strong quarterly results Thursday and a revenue outlook that exceeded analyst forecasts.

There remains room to run in custom AI chips. They are gaining traction among big tech companies looking for alternatives to Nvidia's popular and expensive AI chips. Morgan Stanley estimates the custom-chip market will be valued at around $30 billion in 2027, up from $12 billion last year.

The road to reaching those numbers isn't as obstacle-free as Broadcom's market value may suggest, however.

Custom-chip projects require hundreds of millions of dollars of upfront investment and often don't meet hoped-for performance goals. Google's latest custom AI chips are about half as good as their Nvidia counterparts, TD Cowen analysts estimated in a recent report -- right at the threshold where producing them makes financial sense. In a February report, Morgan Stanley analysts said performance problems with custom chips were "a more common complaint than people think."

Those issues mean big tech companies will hedge their bets and keep turning to Nvidia for a large slice of their AI computing needs. Morgan Stanley analysts estimated Friday that Google would increase spending on its custom chips by between 10% to 20% this year, but would triple or quadruple spending with Nvidia after previously skewing its spending in the other direction.

Once they are in production, custom chips typically cost a fraction of the $30,000-plus Nvidia charges for its most advanced chips. But they aren't always a slam dunk on cost, because big computing systems jam-packed with custom chips often have to use optical networking technology that is more expensive than Nvidia's copper-wire systems.

Then there is the cost of developing software that tells the custom chips what to do -- a chore Nvidia's customers can largely avoid.

External threats hang over Broadcom's custom-chip business as well, including a competitive market in which U.S. chip maker Marvell and Taiwan's MediaTek are increasingly nipping at its heels.

Politics could also interfere with its growth: While Broadcom hasn't yet had to grapple with U.S. restrictions on sales to China, like Nvidia has, analysts believe one of its biggest clients is ByteDance, TikTok's Chinese owner. In a call with analysts Thursday, Chief Executive Hock Tan offered little assurance that Broadcom was insulated from export restrictions. "Nobody can give anybody comfort in this environment," he said.

In the long run, Broadcom's biggest challenge may simply be that its market is more limited than Nvidia's. Custom AI chips are all the rage now, but Nvidia plays in a much bigger pond: The broader AI chip market is expected to grow at a 23%-annual pace in the next half decade to hit nearly $500 billion by 2030, according to a recent assessment from analysis firm TechInsights. Because of their development costs, custom AI chips will almost certainly continue to be the domain of well-heeled tech companies, not a wider swath of corporate and government customers.

All those concerns would be easier to shrug off if it weren't for Broadcom's valuation. The company's forward price/earnings ratio of 33.6 is at a 23% premium to the PHLX Semiconductor Sector Index, near the highest premium Broadcom has commanded in at least a decade. It is also at a 13% premium over Nvidia.

Broadcom has found a profitable niche for itself in the AI boom. But it is a less-comfy one than many investors think.

Write to Asa Fitch at asa.fitch@wsj.com

(END) Dow Jones Newswires

June 08, 2025 06:30 ET (10:30 GMT)

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