China + Smartphones = Disaster?

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Say "smartphones," and a lot of investors start to drool uncontrollably. Mention China, and you'll get the same reaction. So when we're talking about a direct play on Chinese smartphones, the slobbering should reach absolutely torrential proportions. Right?

Well, not always. Witness if you will Spreadtrum Communications (Nasdaq: SPRD  ) . The designer of radio chips for Chinese smartphones rode Tuesday night's fourth-quarter report right into the Twilight Zone. Though the company beat analyst expectations with $0.78 of non-GAAP earnings per American depositary share on $192 million in sales, the outlook for next quarter wasn't quite as impressive. Spreadtrum shares fell as much as 17% on the news and were trading at about 5 times trailing earnings today.

For a company that nearly doubled sales in 2011, a mere 19% year-over-year revenue gain in the next quarter feels like a letdown. CEO Leo Li pins the weak period on a transition to new manufacturing techniques for its smartphone and 2.5G products. He also mentions seasonal effects, but that argument doesn't really hold water in year-over-year comparisons.

Major customer China Mobile (NYSE: CHL  ) also slowed down phone builds recently, as the handset division came under new management. Li believes that the damage from the event won't stretch beyond the first quarter, but investors are latching onto that soft outlook anyhow.

I'd also worry about increasing competition. Spreadtrum's most direct competitors today are European powerhouse ST-Ericsson, local giants MediaTek and MStar Semiconductor, as well as the mobile communications division of global chip titan Intel (Nasdaq: INTC  ) . And if you thought that was a crowd, another Westerner is elbowing its way into this market.

Marvell Technology (Nasdaq: MRVL  ) already claims a 70% market share in the high-end 3.5G version of China's TD-class handset. The company also introduced an even faster version of these chips in this week's Mobile World Congress event.

In short, Spreadtrum needs to watch its back. I don't feel great about the company's chances of navigating these challenges if ramping up a new manufacturing model is enough to derail the revenue train.

This stock certainly merits a spot on your Foolish Watchlist, but the execution here is less than crisp. I wouldn't back up the truck to buy shares on this particular drop. If you're looking for smartphone plays flying under the average investor's radar, you don't even have to look in the Chinese Twilight Zone -- we've compiled three surprising smartphone stocks as American as grandma's apple pie.

Fool contributor Anders Bylund holds no position in any of the companies mentioned. The Motley Fool owns shares of Marvell Technology Group, Intel, and China Mobile. Motley Fool newsletter services have recommended buying shares of China Mobile and Intel. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinion, but we all believe that considering a diverse range of insights makes us better investors. Check out Anders' holdings and bio, or follow him on Twitter and Google+. We have a disclosure policy.

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  • Report this Comment On February 29, 2012, at 5:59 PM, sbucholz wrote:

    Funny how so many were beating the drum on this stock when it was in the high twenties as recently as Q4 of 2011. They couldn't say enough about the potential upside ...on so many buy lists...sleeper...potential giant etc.I guess we all make mistakes...what a disaster.

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