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Broadcom Preferred Stock: 8% Yield Through October (AVGO)

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(This article was co-produced with Hoya Capital Real Estate)

Introduction

I came across the Broadcom, Inc., 8.00% Prfd Compulsory Convertible Stock, Series A due 09/30/2022 (NASDAQ:AVGOP) by searching for my article on Calamos Dynamic Convertible and Income Funds (CCDs). AVGOP is their second largest holding, representing 2.6% of their portfolio. With mandatory conversion at the end of September, AVGOP offers investors a “call option” that pays you while you wait.

Broadcom Quick Tour

AVGO share price
Data by YCharts

Seeking Alpha describes this company as follows:

Broadcom Inc. designs, develops and supplies various semiconductor devices with a focus on complex digital and mixed signal complementary metal oxide semiconductor devices and III-V analog products worldwide. The Company operates in two segments, Semiconductor Solutions and Infrastructure Software. AVGO was incorporated in 2018 and is headquartered in San Jose, California.

Here is how the company describes itself:

Broadcom Inc. is a global technology leader that designs, develops and delivers a wide range of semiconductor and infrastructure software solutions. Broadcom’s industry-leading product portfolio serves critical markets including data center, networking, software, broadband, wireless, storage and industrial. Our solutions include data center networking and storage, enterprise and mainframe software focused on automation, surveillance and security, smartphone components, telecommunications and factory automation.

the Company Website lists six areas where Broadcom is doing design work today:

  • Broadcom’s tip solutions: High-speed Wi-Fi access point solutions maximize Wi-Fi 6/6E connectivity and applications and enable widespread deployment across home and business networks.
  • Data Center Solutions: Data centers are an integral part of modern IT infrastructure. Equipped with advanced networking, compute, and storage equipment, modern data centers are capable of handling huge volumes of data to and from storage terminals, server nodes, and network ports.
  • Financial Services Solutions: Specifically designed for financial institutions, our financial services solutions help businesses manage disruption, better manage operations, accelerate automation, and create a secure, scalable, and compliant environment.
  • Enterprise Security Solutions: Broadcom is a leading provider of enterprise security solutions worldwide, leveraging the breadth and depth of its hardware and software security expertise. Broadcom offers a broad portfolio of integrated security solutions, industry-leading mainframe security and payment authentication software, and a suite of best-in-class Symantec integrated cybersecurity software.
  • Broadband access solutions: With one of the broadest IP portfolios in the industry and extensive product experience in broadband applications, Broadcom offers a comprehensive portfolio of broadband access solutions to meet the “last mile” challenges for global service providers. .
  • Motor drive and control solutions: Within every motor system, there are motor drive and control subsystems for which Broadcom offers a wide range of product solutions, including optocouplers, fiber optic solutions, and motion control encoders.
Broadcom's financial data for the first quarter of 2022

investors.broadcom.com 1Q report

The first quarter ended 01/31/22: revenue grew 16% and operating profit 23% year-on-year. Second quarter results may be available in early June depending on the release date of this report. The report included two Q2 guidance figures:

  • Revenue forecast of approximately $7.9 billion for the second quarter, an expected increase of 20% over the prior year period.
  • Second quarter adjusted EBITDA forecast of approximately 62.5% of forecast revenue.
Broadcom dividend

lookingalpha.com DVD AVGO

AVGO’s forward yield is 2.7% based on the higher dividend payout that began last December. Since the convertible’s value depends on Broadcom’s common stock price, Seeking Alpha has different quotes available on that front:

Ranking of AVGO shares

searchalpha.com AVGO

Understanding the Broadcom Inc. 8% MCNV PFD SR A

Broadcom AVGOP Preferred Shares

nasdaq.com AVGOP

Companies like to issue convertible debt, especially mandatory issues for several reasons, including:

  • They may be issued with a lower coupon than debt securities or preferred stock that do not contain a convertible feature. That said, it appears in this case that the 8% was very generous.
  • In the case of a mandatory issue, the money raised never has to be repaid. Admittedly, there will be some dilution of the shares upon conversion.
  • They can issue shares at a price lower than the current market price. At the time of AVGO’s issuance, the appreciation price was set approximately 17% above the price at which AVGO was selling.
Broadcom AVGOP

QuantumOnline.com

The key points are:

  • There are two interest payments due before this date: $20 each.
  • Payments are eligible for the preferential tax rate.
  • Conversion into 3.0303 AVGO shares will be take place on 09/30/22. There are other ratios but highly improbable now:
Broadcom AVGOP Prospectus

sec.gov/Archives/edgar/data

Four Strategies for Recovering AVGO Shares

The data in this section was collected after the market closed on 04/26/22. To simplify things, zero transaction costs have been assumed. To assimilate the strategies, the wish to own 100 shares was used and the data up to the mandatory conversion date of 9/30/22.

Buy the common

AVGO closed at $560, down $28 on the day, resulting in a buy cost of $56,000. Investors will receive two dividend checks of $410 by October, for a net “cost” of $55,180.

Buy the obligatory convertible

AVGOP closed at $1,780.42. It will take 33 shares of AVGOP to own 100 shares of AVGO, assuming rounding up; otherwise, the investor will receive cash for 0.9999 shares. The purchase cost is $57,854. Two interest payments will be received, $20 per, or $1,320, or a net “cost” of $56,534.

Buy call option

A call option gives the buyer the right to buy 100 shares before the expiration date at the chosen strike price. The October 21 contracts are currently the first options to expire after conversion.

AVGO call option

AVGO call options

An investor wishing to minimize the cost “premium” would choose a deep ITM strike price, such as $300. Using the midpoint, they would pay a premium of $262.85, or $26,285 for a 100-share contract. Since they are not entitled to a dividend as long as they hold the call option, their net “cost” would be $56,285 (premium + strike). If they wanted to take less risk on the downside, they could use the $500 strike where the net “cost” would be $59,200. The additional cost of $3,000 protects them if the price is below $500 at expiry, in which case they can “walk away”. Unlike either of the first two strategies, the investor has capped his loss at the premium paid.

Sell ​​a put option

Writing a put option forces the seller to buy 100 shares of AVGO if awarded, which can happen anytime before expiration, but probably not too far in advance and only if the price is less than the exercise price.

Broadcom Stock Put Options

AVGO put options

Someone who expects recent price weakness to continue into the fall could sell the $500 strike. If they are correct, their net “cost” would only be $46,450, much better than any other strategy. The risk is that any price over $500 means no ownership of AVGO. The investor pockets the $3,550 bonus. Or they could go the other way and sell the strike for $650, increasing the odds that they own AVGO. In this case, their net “cost” would be $53,690 ($650 premium to $113.10). If AVGO is over $650, again no property, but they pocket over $11,000 in bounty income.

Strategy Summary

A common feature of the first three strategies, as opposed to the fourth, is the guaranteed ownership of AVGO shares. This assumes that the Call buyer exercises their option or buys AVGO in the open market because AVGO is selling at a lower price than the exercise price used.

With the conversion price so far below the level at which AVGO is trading, AVGO’s movement should mirror that of AVGO, although I have seen the premium jump as AVGO’s price has recently fallen. Deep ITM calls are expected to follow a similar pattern and currently offer the possibility of lower entry costs than the convertible if a deep ITM strike is used.

Selling a put option should result in the best price regardless of the strike price used as the premium earned, but the investor may see AVGO’s price go up and end up with no action.

Portfolio strategy

Of course, the underlying assumption is that an investor wants to own Broadcom stock. Recent reviews of AVGO by other Seeking Alpha contributors gave it a strong buy rating and three buy ratings. Potential investors are encouraged to read some of Broadcom’s more in-depth analysis.

The end goal is to own a stock that will go up in price. Here is where Wall Street analysts expect the price to go:

AVGO Futures Price

lookingalpha.com WSA Price Projection

This chart shows how well they have predicted the AVGO futures price in the past.

AVGO Price History

seekalpha.com WSA Price History

final thought

For investors who are not comfortable with trading options, forget about AVGOP and buy AVGO shares directly. Options players wishing to secure ownership should consider purchasing a call option for every 100 shares they wish. Put writers must choose between the lowest “net cost” and the odds of owning the stock based on their expectations of what AVGO will sell next fall.