When it comes to technology, investing in the incumbent is always a double-edged sword. On one hand, the company got to where it is today through a combination of smart business decisions and (especially important for technology companies) a material competitive advantage. The best technology companies have competitive advantages that are not so easily surmounted, while less attractive ones may have simply gotten lucky (which implies that the competitive advantage isn't so durable). Today, it's worth analyzing Qualcomm (NASDAQ: QCOM ) , the world's leading mobile chip vendor.
Understanding Qualcomm's chip business
Qualcomm's chip business, also known as Qualcomm Communication Technologies, or QCT, is incredibly diverse. The company offers cellular basebands, connectivity combos, and applications processors, all fully integrated and combined into one single piece of silicon. It is the company's leadership IP across the board, as well as solid integration, that has led the company to win the applications processor socket segment for over 50% of the smartphone market.
Now, this isn't to say that Qualcomm hasn't faced competition over the years. Infineon Wireless, now owned by Intel (NASDAQ: INTC ) was a fierce competitor in the 3G generation, and Texas Instruments (NASDAQ: TXN ) held its own in both applications processors and basebands. However, the investments needed to stay competitive with the market leader are substantial -- Qualcomm's R&D budget topped $5 billion over the last twelve months.
Intel is the biggest threat
Qualcomm has never faced a semiconductor company with the resources that Intel has at its disposal. Texas Instruments was the largest, but the vast majority of its business really has nothing to do with high-performance applications processors. Texas Instruments' products used off-the-shelf graphics and CPU IP stitched together in a system-on-chip. But, Intel's bread-and-butter is computing, which means CPUs, GPUs, and more. Everything that Intel develops to battle Qualcomm in the tablet and smartphone spaces can also be applied to PC processors, a segment twice as large as Qualcomm's chip business.
This means that Intel can not only leverage much of the IP that it develops for this space in other, very profitable segments, but that it can afford to invest heavily in its mobile efforts, subsidized by PC and data-center cash cows. So, can Qualcomm afford to fight a chip price war?
Yes, but it won't be subsidized by chips
Qualcomm's chip business generated $3.2 billion in operating income on just shy of $17 billion in sales. Keep in mind that Qualcomm has already been fighting a price war with the likes of MediaTek, Spreadtrum, and Allwinnner at the low end of the smartphone market, so Qualcomm is no stranger to price wars with competitors willing to eat dirt for margins. However, with Intel muscling onto the scene, this will be the first time in a long time that Qualcomm will have a competitor in the high end with real structural advantages (i.e., in-house fabrication/packaging/testing, process lead, etc.) and the willingness to take dramatic measures to gain share.
Qualcomm can certainly fight a price war at the high end, since two-thirds of the company's operating profits come from its cellular patent licensing and attendant royalty streams (which means that no matter who wins or loses in the smartphone wars, Qualcomm receives a very nice royalty check for each 3G/4G device sold). So, Qualcomm can't subsidize its handset and tablet businesses with other chips, but it has other businesses it can leverage to fight a long-term war with Intel.
Foolish bottom line
This clash of the giants will be very interesting to watch over the next couple of years. At the end of the day, Qualcomm and Intel will probably be the No. 1 and No. 2 players in the mobile chip market, with market share distribution really the only question at this point. But, this is a battle that will rage on for many years before there is stabilization and before margins expand to more sustainable levels.
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