When the mobile applications processor gold rush began, the legions of ARM (ARMH)-enabled semiconductor vendors -- lured by the promise of breaking the "x86 hegemony" in the computing market and becoming rich in the process -- started fighting for the mobile processor crown. However, as time wore on, it became pretty clear that the pot of gold at the end of the rainbow was nothing more than a mirage for all but a select chosen few. Chipmaker Broadcom (NASDAQ: BRCM) looks to be next on the chopping block.
Sizing up mobile chips
The tablet applications processor market is worth about $4 billion today and is growing at about 10%-15% annually. The smartphone applications processor market (which usually includes integrated modems) is worth about $18 billion today. Combined, they're worth about $22 billion and according to ARM, the long-term growth rate for these looks to be about a 13% unit CAGR through 2018.
Source: ARM Holdings.
Given that most of the growth appears to be happening at the low end of the market, the revenue growth CAGR in mobile devices is likely to turn out to be a bit lower as the mix does seem to be biased toward lower-value devices. However, a market worth about $35 billion in 2018 is -- again -- nothing to sneeze at, but as you'll soon see, it still isn't a big enough opportunity for this many players.
What kind of revenue does a company need to be viable?
If we look at the gold standard in mobile processors -- Qualcomm (QCOM -0.94%) -- you'll see that the company invests about $3.5 billion-$3.8 billion per year in operating expenses (R&D and SG&A) for its mobile chip business. The gross margin profile for Qualcomm's chip business is in the range of 40%-45%, and operating margin comes in at about 20% on a revenue base just shy of $17 billion in 2013.
In order to keep up with Qualcomm's R&D machine, a potential competitor is likely going to need to spend about as much, so we're looking at about $3 billion in operating expenses. On top of that, this is a business where gross margins are in the 40%-45% since all of the relevant players are fabless and don't have their own packaging and test facilities. So, in order to really drive breakeven at the kind of investment levels that Qualcomm can afford, a company needs to generate about $6 billion-$7 billion.
In theory, then, this means the market can accomodate about four to five companies running at breakeven by 2018 if the pie were split evenly. However, companies tend not to want to invest heavily in businesses just to break even -- they want to turn a profit. With a 50-50 split, there could be two nicely profitable companies, but this is also an unlikely scenario given history in the semiconductor business (i.e., there is always the dominant player and the secondary one, with the dominant vastly more profitable).
Could Broadcom be that No. 2?
At the recent J.P. Morgan Tech & Telecom conference, CEO Scott McGregor had the following to say with respect to the status of its cellular efforts:
In our conference call, I said that we expect to see feedback from our customers in terms of design wins over the next few quarters, possibly sooner. So I think that the team has done a fantastic job creating these technologies and it's a bit like we have a storefront and we have beautiful products in the window and now over the next couple of quarters, possibly sooner, those customers are going to tell us whether they like the products or not and that's the gating item at this point.
Broadcom's CEO is essentially saying that they now have a set of compelling products that could win designs for the 2015 time frame. If the company can't win those designs (and it can't just be a few designs here or there -- it needs to be enough to be meaningful), then it'll probably be lights out for the Broadcom's cellular efforts.
What does this mean for Broadcom stock?
The great thing here is that this is a pretty classic no-lose scenario for the stock. If Broadcom is actually successful in pursuing cellular and can make good money at it, then this could fundamentally redefine its business, driving quite compelling revenue growth for the company. If Broadcom "fails," then it can probably sell its cellular division to a company like Apple or Samsung, which could then pick up where Broadcom's team left off for their own devices.
Either way, Broadcom is going to either grow its business significantly or it's going to stop the bleeding caused by its cellular investments. Both will have a positive impact on the company's bottom line, but obviously one is much more positive than the other.
