Don't Overlook Spreadtrum

 | Nov 09, 2011 | 10:30 AM EST
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I'm a big bear on China, but any investment there needs to be handled with kid gloves. Earlier this year, a rash of accounting scandals left egg on the face of many investors, including myself, with formerly high-flying companies like China MediaExpress Holdings.

But misery loves company, and I wasn't alone. Hedge fund manager John Paulson's big position in Toronto-listed Chinese forestry company Sino-Forest Corp. was pummeled on allegations of fraud by the investment research firm Muddy Waters.

One exception to the litany of Chinese frauds appears to be tech star Spreadtrum Communications (SPRD), which announces third-quarter results after today's close. Consensus estimates are for the company to earn $0.67 per share on $178.3 million in revenue.

Spreadtrum is a fabless semiconductor company that designs, develops and markets processors for the wireless communications market. By combining semiconductor expertise with their internal software development capabilities, Spreadtrum delivers a complete wireless system solution on a single chip across a wide range of standards.

In the midst of Sino-Forest scandal, Muddy Waters published an open letter to Spreadtrum Chairman Leo Li questioning the company's revenue growth in the company's 2010 and 2011 financial results. The stock fell to as low as $8.59 per share in June.

Having seen other Chinese small-caps experience the wrath of Muddy Waters, Spreadtrum management's response was swift. It hosted a conference call, issued a cash dividend of $0.05 per share and executed 35% of the $100 million stock repurchase program. The company's CEO and CFO Xiaoning Gao bought $3.2 million of Spreadtrum's stock on the open market.

The strategy worked. Since then, Spreadtrum's stock has been on fire, more than tripling to Tuesday's closing price of $27.73.

I continue to believe that Spreadtrum is destined for long-term success for a simple reason: It already benefits from a lock on China's mobile-phone market, recently securing a contract for the TD-SCDMA Chinese mobile standard for the red hot Samsung Galaxy S II smartphone that targets China Mobile's (CHL) 38 million 3G users. And because it is involved in the strategic area of semiconductors, the Chinese government informally designated Spreadtrum as one of China's high-tech champions. As such, the company benefits from government-brokered deals and favorable financing from China's state banks -- exploiting the unwritten rules behind business success in China.

That's not to overlook Spreadtrum's achievements. Its technology is developing quickly, and it has made great strides gaining market share in the 2G, 2.5G, and 3G TD-SCDMA market. And just as Taiwanese firms undercut Japanese semiconductor manufacturers a few years back, the Chinese are now undercutting Taiwanese firms like Mediatek Inc.

Spreadtrum is expected to launch low-end ICs that can run Android 2.2 OS and dual-mode 4G ICs -- in direct competition with its Taiwanese rival. A recent acquisition of MobilePeak also allows Spreadtrum to become a player in the global 3G standard. The technology it acquired also puts it in place to rival both Mediatek and Qualcomm (QCOM) in the 4G world.



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