Broadcom's AI Semiconductor Surge and Software Momentum Fuel FY2026 Growth

Broadcom (AVGO) stands at the intersection of two megatrends: the AI revolution and the shift to cloud-native infrastructure. With its dual engines of AI semiconductor dominance and Infrastructure Software leadership, the company is positioned to deliver 60%+ AI revenue growth in FY2026 while maintaining margin resilience. Here's why investors should consider this buy-rated opportunity.

1. AI Semiconductor Growth: A 60%+ YoY Runway

Broadcom's Semiconductor Solutions segment is firing on all cylinders. In Q2 FY2025, AI-related revenue hit $4.4 billion, a 46% YoY jump, with Q3 guidance projecting a further acceleration to $5.1 billion—marking the 10th consecutive quarter of growth. Management has explicitly stated that AI semiconductor deployments will “exceed expectations” in FY2026, driven by hyperscalers' investments in large-scale AI clusters.

Key Catalysts:
- Tomahawk 6 Adoption: Broadcom's 100G/200G Tomahawk 6 switches are critical to hyperscalers like Amazon, Google, and Microsoft, enabling high-speed networking for AI workloads.
- XPU Ramp: Custom AI accelerators (XPUs) are driving a structural shift in the semiconductor mix. While XPUs have lower margins than networking chips, their volume growth will offset this via economies of scale.

2. Infrastructure Software: VCF-Driven Recurring Revenue

Broadcom's acquisition of VMware has transformed its Infrastructure Software segment into a cash cow. In Q2, the segment grew 25% YoY to $6.6 billion, with margins soaring to 93%—up from 88% in FY2024. The VMware Cloud Foundation (VCF) platform's transition to subscription-based licensing is key:

• VCF ARR Growth: VMware's subscription revenue is expanding at >30% YoY, with over 50% of customers now on multi-year contracts. This creates sticky, predictable revenue streams.
• Synergy Play: Broadcom's ability to bundle its AI networking hardware with VMware's software stack gives it a unique value proposition in hyperscale data center builds.

3. Margin Resilience: A Balancing Act

While XPUs' lower margins pose a near-term challenge, Broadcom's diversified portfolio and operational discipline ensure margin stability.

Gross Margin Dynamics:
- Semiconductors: Q2 gross margin rose 140 bps YoY to 69%, aided by high-end networking chip sales. Even with XPU mix shifts, the segment's 66%+ Adjusted EBITDA margin (Q3 guidance) signals robust cash generation.
- Software: Infrastructure Software's 93% gross margin acts as a buffer, offsetting semiconductor margin pressures.

Operating Leverage:
- R&D Efficiency: Broadcom's $1.5 billion Q2 R&D spend is focused on AI-specific chips (e.g., XPUs for inference workloads), which command premium pricing.
- Shareholder Returns: With $6.4 billion of free cash flow in Q2 (a record), Broadcom returned $7.0 billion to shareholders—a testament to its financial flexibility.

4. Balance Sheet: Strong, but Debt-Watchers Take Note

Broadcom's balance sheet is solid, with $9.5 billion in cash and $15.8 billion in Q3 revenue guidance. However, its net debt stands at $32 billion, primarily tied to the VMware acquisition. Risks include:
- Debt Service Costs: Rising interest rates could pressure margins.
- Hyperscaler Spending Cycles: A slowdown in AI capital expenditures could disrupt growth.

Investment Thesis: Buy—Multi-Year AI Exposure Justifies the Call

Why Buy?
1. AI's Long Tail: XPUs and Tomahawk switches are critical to hyperscalers' AI infrastructure, creating a multi-year revenue runway.
2. Software Flywheel: VMware's subscription model ensures recurring cash flows.
3. Margin Stability: Even with XPU mix shifts, Infrastructure Software and operational discipline will keep margins above 60%.

Catalysts for FY2026:
- XPU Volume Gains: XPUs could contribute >30% of AI revenue by FY2026, up from 20% today.
- Tomahawk 6 Adoption: Already shipping to major cloud providers, this chip is a 5-year revenue driver.

Risks: Debt management and macroeconomic headwinds remain, but AVGO's cash flow mitigates these concerns.

Final Take

Broadcom's dual-engine growth model—combining AI semiconductor leadership with VMware's software moat—positions it to thrive in FY2026 and beyond. While margin pressures from XPUs are real, the 60%+ AI revenue growth trajectory and 93% software margins create a compelling risk-reward profile. Investors seeking exposure to AI's infrastructure boom should consider a buy, with a price target reflecting FY2026's $25 billion+ AI revenue milestone.

Rating: Buy
Target Price: $650 (Reflects 25x FY2026E P/E)