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Broadcom braves telecom wild

The networking chipmaker will face perhaps the toughest competition in its history as it expands its empire from the cable market to telecommunications equipment, analysts say.

Networking chipmaker Broadcom will face perhaps the toughest competition in its history as it expands its empire from the cable market to telecommunications equipment, according to analysts.

The Irvine, Calif.-based company made its name with chips that power cable modems, cable set-top boxes, and components for corporate networks, called LANs (local area networks). Now it has set its sights on equipment that runs communications networks in metropolitan areas and other high-end niches.

In doing so, Broadcom is moving from an area where it dominates to a market already populated with entrenched competitors like Applied Micro Circuits (AMCC), Vitesse Semiconductor and PMC-Sierra.

"It's going to be a fight, no doubt about it," said Peter Andrew, an analyst at A.G. Edwards.

Broadcom's ambitions come at a time of great flux in the networking industry. Other members of the networking "food chain," from component makers like JDS Uniphase and Agere Systems to network operators such as Sprint, WorldCom and XO Communications, are grappling with a significant downturn in their businesses and a more conservative mood toward the industry on Wall Street.

Broadcom, which has also seen its stock price suffer, on Friday introduced a new compensation plan that will allow company employees to trade in worthless stock options for new ones priced close to current market levels. Chief Executive Henry Nicholas said "this is the best way to continue to retain and motivate our most important asset, our employees."

The market for telecom gear continues to grow fast, however, making it a potentially lucrative sector to jump into. Sean Lavey, an analyst at IDC, says the value of chips used in the LAN market increased about 10 percent, to $2.3 billion from $2.1 billion, from 1999 to 2000. That is slow compared with the value of chips used in telecommunications networks--often called WANs (wide area networks)--which expanded between a range of 30 percent and 40 percent.

"Broadcom realizes that the LAN market has reached a point of saturation," Lavey said.

A recent study by Infonetics Research predicts that spending on metropolitan network equipment in the United States and Canada will grow from $6.3 billion in 2000 to $17.2 billion by 2003, an increase of 175 percent.

But moving into that market won't be easy.

Facing the competition
Analysts say competition in metro equipment will present Broadcom with new challenges.

AMCC appears to offer the stiffest competition. "They've done an excellent job in keeping up with next-generation technology," said Alex Gauna, an analyst at Banc of America Securities.

But Broadcom has a history of dismissing concerns about rivals. "They are pretty self-aware that they are good," said Arnab Chanda of Lehman Brothers.

The company's success in establishing itself in other markets might provide some justification for its confidence. Broadcom moved into the LAN market in the 1990s and went up against the likes of Intel and 3Com, but still managed to become a leader in that market.

But customers in the telecom market--the phone service carriers--may expect more than Broadcom's cable customers, Andrew said. Their networks need to be bulletproof, technologically. He believes customers might be more forgiving of a problem with a $300 set-top box, but it becomes a different story if there's a problem with a $300,000 telecommunications switch.

The company must also keep its eye on larger issues like the integration of the more than 13 companies it has acquired over the past 18 months. Broadcom has taken Cisco Systems' approach of growing by acquisitions, scooping up much-needed technology instead of developing it from within.

Analysts say this strategy has paid off for the most part and that the company has shown diligence in selecting the right companies at the right price. But the pace could cause digestion problems.

"It's a challenge to integrate that many companies that quickly," said Gauna, who adds that most of the acquired companies lead in their respective markets before uniting with Broadcom.

Broadcom might also feel price pressure as equipment makers begin to clear out inflated inventories in the second quarter, and therefore order less from chipmakers. "The real clearing is going to happen this quarter, and it's going to be ugly," predicts Andrew.

This has already started to happen. Cisco accounted for less than 10 percent of Broadcom's first-quarter revenue, compared with 12 percent in the previous quarter. 3Com went from almost 23 percent to 15 percent in the quarter as well, or $85 million to $48 million. Motorola held steady at 19.4 percent, sliding from 19.8 percent.

Broadcom also has other concerns in the telecom market. Cisco, Nortel Networks and Lucent Technologies have taken a huge hit as telecom service carriers have slashed their spending.

Overall, however, Banc of America Securities' Gauna likes Broadcom's chances. "Broadcom always finds the most rapidly growing market and challenging design opportunity that it can and goes after it with laser-like focus," he said.