Earlier this year, QCOM caught our attention when CEO, Paul Jacobs announced that it would be implementing its S4 Snapdragon processor, encroaching upon incumbent Intel’s (NASDAQ: INTC) bread and butter. INTC responded with the Atom chip for Lenovo smartphones (K800). Fast forward to May and the battle has heated up. Now that both are manufacturing processors for phones and tablets, investors are pitting them against one another. Overall, we think that QCOM’s outperformance is justified and that wireless device companies will stick with QCOM’s product. INTC’s strategy is highly dependent upon the success of its Ultrabook. We are not sure it will be able to take iPad sales with its hybrid product.
QCOM also faces fierce competition in the quad-core mobile processor arena. The dual-core Krait Snapdragons were well-received, but QCOM has made an interesting choice to not take on Nvidia (NASDAQ: NVDA) and Samsung head-to-head yet. NVDA and Samsung already have quad-core products in the market, so QCOM’s tactic is to improve performance of the current product line before increasing the number of cores. And frankly, quad-core chipsets are more expensive to include in a phone, so we view QCOM’s decision favorably. Sticking to and enhancing its current competency is a smart move instead of rushing into another market.
Now smartphones have been seeing slowing but nonetheless, healthy growth. Many analysts have subsequently lowered global smartphone estimates for the year, which will likely exacerbate the seasonality that this industry sees; the iPhone 5 launch will come in the second half of the year and more than one third of total smartphone volumes will come in Q4 as a result. US carriers seem to be reducing upgrade promotions but subsidies in China are rising, so we are not too concerned. Total global penetration is still low relative to North America (32.5% versus 47%), giving QCOM a nice runway for international growth.
The real sweet spot with QCOM is its technology licensing business (QTL), which contributes approximately 70% of EBT and is projected to grow in the mid teens for the next two years. The changing preferred device mix toward smartphones and tablets should bump up average selling prices and increase royalty rates. Additionally QCOM’s CDMA technologies (QCT) has done an excellent job of aligning itself with the top software platforms, which will help market share gains in chipsets. In the chipset market, Taiwan-based MediaTek (2454.TW) is major competitor in low end phones. QCOM has been ramping up in this space, resulting in some margin compression. However, in contrast to MediaTek we see QCOM’s performance improving with the foray into a lower margin business. We note that the chipset market is very competitive but that licensing revenues have helped buoy net margins.
Overall, QCOM operates in highly competitive markets, but we believe that it is among the best ways to play 3G growth. Shareholders continue to reap rewards from the lucrative licensing business and effective jump into the chipset business. With new products in the pipeline, we think there potential long term upside from new applications and products. In short, we are buyers.
