Risks Loom But Qualcomm Inc. (QCOM) Remains a Promising Growth Stock

Driven by exponential growth in smartphone shipments, chipmakers such as Qualcomm (QCOM) and Broadcom (BRCM) have seen their addressable markets increase. As smartphone manufacturers look to integrate more features, chipmakers need to continually upgrade their chipsets and release new ones, which is why demand for smartphone chips continues to remain strong.

The need for low power consuming processors for a better battery life has been a prime concern for various smartphone manufacturers, but Qualcomm seems to be addressing that need now. Windows RT is among the first operating systems that incorporates a processor to run on low power chipsets. It uses Qualcomm’s processors based on the ARM architecture.

Qualcomm has already been winning orders for its Snapdragon series of processors from smartphone manufacturers like Sony, Samsung, HTC, and Xiaomi. The sales of the Snapdragon 800 processors are expected to increase due to the increased deployment of 4G LTE in key markets such as the U.S. and China.

However, Broadcom poses a tough challenge to Qualcomm in chips for modems, wireless, and LTE applications. It recently acquired Japan-based LTE wireless chipset company Renesas Electronics for $164 million . Chips manufactured by Renesas are already certified by leading wireless carriers like AT&T, Vodafone, Orange, EE, and NTT Docomo. This deal gives further impetus to Broadcom in the 4G modem market, as it looks to cut into Qualcomm’s share. But then, Qualcomm has its own set of advantages.

Qualcomm’s licensing policy can leverage more growth in the future

Qualcomm is now focusing further on its licensing business to ramp up its top line. The company currently holds numerous wireless patents, enabling it to earn royalty fees from various handset manufacturers that use Qualcomm’s chipsets. Currently, the major chunk of its revenue comes from the sale of chipsets.

Qualcomm faces fierce competition from other chip manufacturers like Intel and Samsung. But with the focus on its licensing policy, it remains in a position to keep its revenue stable while also profiting from growth in smartphone shipments that use its intellectual property.

The only concern with the licensing policy would be the pricing of the handsets since Qualcomm does not have any control over that. But no business is risk-free and under any situation, Qualcomm is benefiting with this business strategy and expects further growth. The margin in the licensing business is higher than selling chips, and this has a positive effect on the bottom line.

A threat for Qualcomm

Qualcomm is facing regulatory problems in China. Recently, China’s National Development and Reform Commission (NDRC) launched an antitrust probe. This was a surprise for Qualcomm as it was not aware of any violation. The Chinese government’s policy of royalty further favors local suppliers, making life difficult for Qualcomm.

Organizations in China are spending heavily to acquire Chinese mobile chipmakers. Spreadtrum Communications and RDA Microelectronics were acquired by Tsinghua Unigoup. Both these companies were on similar technology platforms as that of Qualcomm, creating further competition for the chipmaker in the Chinese market.

RDA Microelectronics & Spreadtrum are known for their low-cost baseband chips. Players such as Qualcomm could face a fierce price war from both these companies, who can now count on financial support from Tsinghua.

Another threat

Apart from the above two companies, U.S. chipmaker Broadcom also has the potential to hurt Qualcomm’s stronghold on the LTE market in 2014. 2014 is an important year for Broadcom as it is relying heavily on the success of LTE growth.

On the other hand, the market for low-cost smartphones is on an upward trend, with the biggest market being China. Smartphones below $250 are anticipated to account for 46 % of the global smartphone market by 2018, up from 28% in 2012. To tap this budding market, Broadcom is collaborating with low-cost smartphone manufacturers in China.

Chinese manufacturers like TCL and K-touch have incorporated Broadcom’s dual core chipset for their 3G smartphones. These 3G smartphones are offered at affordable prices and could help Broadcom enjoy strong growth.

Broadcom should also benefit from the evolution of the Wi-Fi standard. It is a pioneer of 5G Wi-Fi and expects that its customers will gradually transition to 5G Wi-Fi going forward and help Broadcom grow further. However, Broadcom is late to the 4G modem party and the acquisition of Renesas could be thought of as a desperate move by the company as it looks to challenge Qualcomm. Qualcomm commands 63% of the cellular baseband market, according to Strategy Analytics, while Broadcom’s is still in the single digits. Thus, the road ahead for Broadcom isn’t as rosy as Qualcomm.

Conclusion

Broadcom is having difficulty growing its business. Revenue growth in the previous quarter was a mere 2.9% from the year-ago period. Comparatively, Qualcomm’s revenue grew 33% in the recently-reported fourth quarter while net income improved 18%. Also, Qualcomm is cheap at 19 times trailing earnings while Broadcom remains expensive at a P/E ratio of 34. Hence, Qualcomm’s diversification and leading position in the baseband market are reasons why investors should consider buying it to benefit from growing sales of mobile devices.

However, the threat of Chinese chipmakers cannot be ruled out for Qualcomm. Also, while Broadcom might not be a good investment, it can surely rain on Qualcomm’s parade through its partnerships in the Chinese market and its recent acquisition. Hence, investors should keep a close watch on Qualcomm and keep track of its business in China.

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