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Is Qualcomm Truly Future Ready?

By Subhadeep Ghose - Feb 3, 2014 at 10:00PM

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Qualcomm's correct anticipation of the mobile-devices space makes this a must-have stock

The most important thing that investors should note about leading mobile chipmaker Qualcomm (QCOM -2.98%) is the company's uncanny ability to correctly anticipate how things are going to turn out in the mobile-devices space. This is a company that was quick to change gears when it started to bear the brunt of the slowdown in profits due to the dwindling number of customers for high-end smartphones in developed markets.

On one hand, Qualcomm started to focus more on emerging markets such as China and on making low-end chipsets for less costly handsets preferred by customers in these regions. And on the other, it also curbed operating expenses in order to maintain profitability. The results played out as expected during Qualcomm's recent first-quarter performance. While the company's revenue at $6.6 billion fell slightly short of Street expectations, thanks to a lower profit margin from sales of its high-end chipsets, its EPS $1.26 per share managed to stay ahead of analyst estimates of $1.18 per share.

In fact, Qualcomm's newly found confidence in emerging markets was enough to boost management to raise the profit guidance for the entire year, which in turn bumped up the stock price by around 3%. But then, is Qualcomm's current level of confidence truly justified?

Why China in the first place?
One of the crucial deciding factors for Qualcomm to focus on China was the government's decision to award licenses to wireless providers for the launch of 4G LTE mobile-network operations. Out of these, Qualcomm zeroed in on China Mobile -- the nation's and also the planet's largest wireless provider, with around 763 million subscribers -- due to a number of reasons.

Qualcomm derives its sales and profits in two distinct ways. While one of them centers on sales of its smartphone chips, the other is based on royalty fees derived from smartphone makers and providers that use the CDMA mobile-networking standard that Qualcomm pioneered. However, with China Mobile's 3G network standard running on an indigenously developed TD-SCDMA platform, most of the handset makers that use the former's 3G network avoid paying royalty fees to Qualcomm.

Given that the company's growth is slowing elsewhere, Qualcomm's urgent need to tag onto China Mobile's 4G initiative hence becomes all the more apparent. On the other hand, a large percentage of China's mobile-phone users still possess basic-feature phones and are fast upgrading to the smartphone variety, translating into a goldmine of opportunity for companies like Qualcomm.

Geared up for challenges
Qualcomm is certainly well-equipped for China's expected LTE boom, given that it accounts for almost 97% of global LTE market revenue and has been making LTE-enabled chips for nearly two years now. That has also enabled it to widen the gap with fellow competitor Intel (INTC -1.37%), which is still fumbling to gain a foothold in the mobile-devices arena. With less than 1% share of the global smartphone chip market, Intel now also has to contend with the problem of idle production capacity.

On the other hand, despite being a late entrant, Qualcomm's smaller industry peer Broadcom (NASDAQ: BRCM) also seems to be benefiting from the global LTE upgrades, having reported estimate-beating sales and profits during its recent fourth quarter.

All the right moves
Qualcomm's dedicated efforts to focus on the Chinese market indeed seem to be part of a well-directed strategy. Two of China's leading phone makers, Huawei and Lenovo, recently delivered stellar quarterly performances. While Huawei recorded a whopping 57% increase in phone shipments during its fourth quarter, Lenovo's handset unit sales went up by a substantial 47% over those of the year-ago period. Incidentally, Huawei and Lenovo happen to be the world's third and fourth biggest smartphone manufacturers, respectively .

Points to ponder
Despite its huge potential, China may prove to be a tough nut to crack for Qualcomm that is already at the forefront of a recent antitrust investigation by the region's government. The company is also likely to face stiff competition from local chipmakers such as MediaTek, whose rock-bottom prices may be hard to match.

Some Foolish parting thoughts
Having said that, the single-biggest factor that should work in favor of Qualcomm in China is its dominance in the LTE arena. The company's efforts in that region should pay off handsomely in terms of volume sales and licensing revenue sometime later this year, as providers upgrade their LTE networks and usage patterns start to grow.

Many Chinese phone makers have global ambitions as well, as evidenced by Lenovo's recent decision to acquire the Motorola Mobility handset division from Google, which again translates into important opportunities for chipmakers like Qualcomm. And with Japan's NTT DoCoMo recently tying up with Apple to offer iPhones on its network, it seems Qualcomm can still reap some gains from developed markets. This is certainly the time to help yourself to a large portion of this stock, and then sit back and enjoy the benefits a couple of quarters later.

 

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QUALCOMM Incorporated Stock Quote
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