Qualcomm's Mobile Chip Business Could Be Well-Positioned to Beat Low Expectations

 | Mar 14, 2017 | 8:54 PM EDT
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While the Nasdaq has more than doubled over the last six years, Qualcomm's (QCOM)  shares have effectively tread water. And their performance would be worse still if Qualcomm's pending $47 billion deal to buy NXP Semiconductor (NXPI) (financed in large part via offshore cash) wasn't so well-received by markets last fall.

Qualcomm's performance does show, however, that fears about the long-term challenges faced by its core mobile processor/modem and IP licensing businesses have been heavily priced in. What doesn't seem priced in is how the company's chip business might be poised to beat a low bar thanks to Android share gains and non-mobile growth.

Taiwan's Digitimes, which appears to have good Asian supply chain sources, reports Qualcomm's recently-launched Snapdragon 835 flagship processor is helping the company take share at the expense of top rival MediaTek, as OEMs opt for the 835 instead of MediaTek's Helio X30 processor. It adds the X30, made using Taiwan Semiconductor's (TSM)  cutting-edge 10-nanometer manufacturing process, isn't expected to see volume shipments until the second quarter.

The Snapdragon 835 is made using Samsung's 10-nanometer process, and is expected to ship within some of the Galaxy S8 models Samsung is due to launch this spring. Other models are expected to rely on Samsung's Exynos 8895 processor.

The Digitimes report comes a couple weeks after one stating Qualcomm's Chinese processor share is set to top 30% for the first time since the second quarter of 2012. The superiority of the 4G modems built into Qualcomm's processors was cited as the reason.

While Digitimes' market share estimates/forecasts generally need to be taken with a grain of salt, there are several factors and trends that suggest Qualcomm is in good position to regain some of the Android share it has lost in recent years to low-cost processors from the likes of MediaTek and China's Spreadtrum.

1. 4G penetration rates and download speeds are rising in many emerging markets - 4G support is increasingly seen as a prerequisite for mid-range and high-end phones sold in China and elsewhere, and as carriers upgrade their 4G networks to support carrier aggregation and other advanced technologies, more advanced modems are needed to keep up.

Digitimes' February report noted that Qualcomm is the only app processor supplier trusted by Chinese OEMs to provide reliable modems supporting Category 7 LTE (300Mbps peak download speeds). The Snapdragon X16 modem baked into the Snapdragon 835 supports Category 16 LTE (1Gbps peak speeds).

2. Many OEMs want processors with integrated modems - While Apple (AAPL) is comfortable pairing standalone Qualcomm and Intel modems with the company's A-series app processors within iPhones, most Android peers want integrated solutions. That hurts Intel, which has made big strides towards narrowing Qualcomm's historical 4G modem edge but has all but exited the smartphone app processor market, save for some licensing deals with Chinese chipmakers.

Also: While Samsung has developed Exynos processors with powerful 4G modems built in, the company has had little success selling them to other Android OEMs, who are naturally wary of becoming dependent on a rival.

3. Top-tier Chinese OEMs are gaining share against smaller rivals - IDC estimates China's top-5 smartphone vendors -- Apple plus local OEMs Oppo, Huawei, Vivo and Xiaomi -- had 66.5% of the market in 2016, up from 59.7% in 2015. This benefits Qualcomm, whose share is stronger with top-tier OEMs than it is with their lesser-known rivals.

In a recent upgrade note for Skyworks (SWKS) , Mizuho analyst Vijay Rakesh reported Huawei, Vivo and Oppo all expect strong 2017 smartphone growth, even as "pockets of weakness" exist among smaller OEMs due to weak low-end demand and component shortages.

4. The Snapdragon 835 looks like a compelling product - Qualcomm thought outside the box a little bit with the 835. Instead of simply trying to develop a chip that would turn in eye-popping benchmark scores, it worked hard to lower the chip's power draw, heat dissipation and die size relative to its predecessor (the Snapdragon 820), while still delivering moderate performance gains. It also put effort into optimizing the 835's ability to run virtual reality (VR) headsets, including smartphone-powered products such as Samsung/Oculus' Gear VR and headsets based on Google's Daydream platform.

Growing sales for Qualcomm's non-mobile processor offerings could also give its chip business a boost. Attach rates for complementary RF and connectivity (Wi-Fi/Bluetooth) chips have been strong with many OEMs, an RF chip JV with Japan's TDK launched in February and design wins are being recorded for Qualcomm's Sense ID fingerprint sensor solution. And outside of the mobile market, Qualcomm has reported seeing growing sales for chips going into cars, IoT devices and Wi-Fi access points.

On the flip side, the potential loss of Qualcomm's remaining iPhone modem business to Intel is a very real risk: With Apple and Qualcomm now in a bitter legal battle, it's quite conceivable that Apple will choose to solely rely on Intel's new XMM 7560 modem (1Gbps peak speeds) for this fall's iPhone launches. And though the companies still buy heavily from Qualcomm, one can't ignore the fact that Huawei, Xiaomi and LG have joined Apple and Samsung in developing their own app processors.

But the bar has been set quite low: Qualcomm has guided for its MSM (processor/modem) chip shipments to be down 2% to 13% in the January quarter, and analysts expect the chip division's total sales to drop 1% in fiscal 2017 (ends in September) to $15.2 billion. Shares trade for just 12 times a fiscal 2018 EPS consensus estimate of $4.79, and those figures don't account for an NXP deal that's bound to be highly accretive to earnings.

Against such a backdrop, markets could react very favorably to some good chip news.

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