Can Qualcomm Inc Crack the Chinese Puzzle?

Qualcomm's LTE dominance should enable it to reap the benefits of the Chinese network upgrade sooner or later

Apr 28, 2014 at 3:00PM

Leading chip manufacturer Qualcomm (NASDAQ:QCOM) seems to have run into a rough patch as less-than-expected demand for faster LTE-based smartphones in China pose a hindrance to its growth plans.

Despite recording a 5% increase in profit during its recently reported second quarter, Qualcomm's revenue and profit guidance for the current period failed to match up to analyst expectations. Market confidence nosedived as company shares fell by a substantial 5.9%.

With profits not reaching expectations as a result of slowing high-end smartphone sales in the developed markets, Qualcomm's found it necessary to change gears and focus on making chips for smartphones targeted at cost-conscious consumers in leading emerging markets such as China. But then, the company's hopes of making up for the lowered profitability through sheer volume in those markets do not seem to be shaping up too well at the moment.

It's time to take a closer look at Qualcomm's current situation.

The root of the problem
Qualcomm started to focus on China when the nation's government awarded licenses to wireless providers that enabled them to launch 4G LTE mobile-network operations. The obvious priority was China Mobile (NYSE:CHL), the country's -- as well as the planet's -- biggest wireless provider with more than 770 million customers. But, there was a problem.

While a large part of Qualcomm's revenue comes from the sale of its smartphone chips, the company has also pioneered the CDMA technology that serves as the global standard for 3G networks. This entitles it to a royalty fee from smartphone vendors and providers that use this technology, with the exception of China Mobile that uses a different homegrown TD-SCDMA network standard. And that in itself is reason enough for Qualcomm's desperation to tag on to China Mobile's LTE initiative.

The problem itself
Having an indigenous network standard that is compatible with fewer handsets, China Mobile's market dominance is being increasingly challenged by rivals such as China Telecom and China Unicom that offer popular handsets operating on globally accepted 3G standards. While this does translate into an opportunity to benefit from royalty fees for Qualcomm, the company faces stiff competition from local chipmakers, such as MediaTek, whose chips can be found in 3G enabled handsets made by Chinese phone makers .

This means that the company can do little else other than wait and watch for China Mobile to boost its LTE enabled handset sales. And with the wireless provider having added less than 3 million subscribers on its new 4G LTE network till March this year, Qualcomm's current situation is understandable.

The possible bright spots
But then, China Mobile is unlikely sit with its hands folded while its competitors reap the benefits. Already in the process of investing a whopping $12 billion behind building the 4G LTE network infrastructure, the company aims to offer discounts on LTE compatible handsets as well.

And given that this is all part of the company's plans to add 100 million subscribers on its new network by the end of this year, the potential for Qualcomm can well be imagined. With the sale of LTE enabled handsets expected to pick up in China by the later half of this year, Qualcomm's licensing revenue, which it reports as arrears one quarter later, should see a significant boost six months down the line.

What about the competition?
Accounting for around 97% share of global LTE market revenue, Qualcomm is certainly well-positioned to reap the benefits when the network service picks up speed in China. That also places it well-ahead of rival chipmaker Intel (NASDAQ:INTC) that is still struggling to design its first generation of LTE-enabled processors. Having reported a stunning $929 million operating loss for its newly created mobile and communications reporting segment, Intel is also facing the prospect of idle production capacity for some time now.

Some Foolish final thoughts
Cracking the Chinese puzzle is proving to be an uphill task for Qualcomm, and matters are now more complicated by the company being at the forefront of proposed government investigations into its operations in that region. But then, given Qualcomm's dominance in the LTE arena, all that patient investors need to do is to keep a close eye on China Mobile's efforts at popularizing the new network.

As LTE usage patterns start to grow among Chinese consumers, everything else should automatically fall in place for the chip manufacturer. With the stock price going down a bit, this may actually be a good time to acquire more of Qualcomm and wait for the results to play out by the end of this year.

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Subhadeep Ghose has no position in any stocks mentioned. The Motley Fool owns shares of China Mobile, Intel, and Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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