With a trillion-dollar revolution now beginning that will last for years, an investor can't help wondering about the best way to capitalize on the coming wave of mobility.
Component suppliers are among the more promising possibilities, even if they're somewhat hidden. The harder question to tackle is which suppliers to pick. Qualcomm
Intellectual property: Qualcomm is one of the largest holders of 3G technology patents. Virtually every 3G device made contributes to the company's royalty revenue, since its broad portfolio of intellectual property is unavoidable for 3G devices. We are now seeing wireless technologies transition from 3G to 4G, and Qualcomm also has patents on 4G standards LTE and WiMAX. It has less of a presence there, though, so 4G royalty rates tend to be lower than what it can garner from 3G.
However, emerging markets still have very low 3G penetration, so even after the U.S. transitions to 4G, there is still opportunity in growing areas such as China and India, among others. For example, according to figures released earlier this year by the National Bureau of Statistics of China, the world's most populous nation had 859 million mobile phone users last year (64% of the population), an increase of 112 million from the prior year. Only 47 million of those were 3G mobile users, representing 3G penetration of 3.5% of the 1.34 billion population as of the end of last year.
All that and a bag of chips: The bulk of Qualcomm's revenue still comes from selling chips and other integrated circuits, comprising 65% of sales in the just-finished fiscal year, with the remaining 35% from licensing. Qualcomm has been scoring handfuls of design wins, in part because of its integrated baseband approach. Its standalone baseband chip kicked Intel
-owned Infineon out of the Apple (Nasdaq: INTC) iPhone 4S this year. Apple uses its own custom ARM Holdings (Nasdaq: AAPL) -based chips instead of Qualcomm's ARM-based Snapdragons. (Nasdaq: ARMH)
is also looking to integrate basebands into its own ARM-based Tegra processors, incorporating its $367 million purchase of Icera. NVIDIA's codenamed "Grey" member of the Tegra family is set to include an integrated baseband next year. The arms race between these two chipmakers continues to escalate, as NVIDIA's Tegra 3 is the first quad-core mobile processor, with Qualcomm's quad-core Snapdragon due out next year. Either way, Qualcomm is one of the clear leaders in mobile chips. (Nasdaq: NVDA)
Intellectual property: Relying heavily on intellectual property can also be a negative. Lawsuits are a reality for any company that monetizes patents, and legal costs can mount quickly and become distracting for management. By specializing in IP, the company needs to stay ahead of the curve in technology. R&D expenses rose 22% last year, and that trend will continue for the foreseeable future as standards progress. If Qualcomm fails to develop IP in relevant technological standards, it may eventually kiss its royalty revenue and R&D dollars goodbye.
Margins: While Qualcomm currently enjoys a healthy operating margin -- 33% last quarter, which is higher than NVIDIA's 19 -- there are a few looming factors that could cause Qualcomm's margins to take a precipitous hit. The aforementioned lower 4G royalty rates are one possibility. The company also sees average selling prices falling slightly in the coming year, which reduces its royalty revenue.
- It expects ASPs between $197 and $209, lower than the range of $203 to $209 in fiscal 2011 and the range of $204 to $210 seen in the fourth quarter. Qualcomm has little say in retail pricing, which is left to OEMs and carriers. Competition from the likes of NVIDIA, Intel, Broadcom
, and Texas Instruments (Nasdaq: BRCM) , among others, in the market for various mobile component chips can also hurt pricing power, further exerting downward pressure on margins. (NYSE: TXN)
- Valuation: Trading at 20.2 times earnings, shares aren't cheap. They're more expensive than NVIDIA's 13.5 multiple, but they've also put up better growth over the past five years. Qualcomm has grown its top and bottom lines by 14.7% and 13.3%, respectively, over that time period, compared with NVIDIA's 8.3% and negative 4.8%.
Qualcomm is a buy. It has entrenched itself in a crucial role within the mobile supply chain, and that's not changing anytime soon. It will need to stay abreast of changing technological trends, but it has a long track record of doing just that.
The company is one of the best picks among mobile component suppliers, and I'll take it two steps further. Not only have I recently sold a bullish put spread on the shares in my personal portfolio (which has numerous component plays), but I will also go ahead and give it an "outperform" CAPScall today. Qualcomm really is the king of the mobile future.
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