Over the last several years, semiconductor maker Broadcom (UNKNOWN:BRCM.DL) has invested a lot of money in trying to catch up to baseband industry leader Qualcomm (NASDAQ:QCOM), which is estimated to control 95% of the emerging LTE market. As a result, Broadcom's largest segment, mobile and wireless, reported stagnating revenue in 2013 and a $32 million operating loss in the first quarter of 2014. Since the rest of Broadcom's business is doing very well, investors and analysts were calling for Broadcom to reconsider its mobile strategy, which included providing baseband modems as well as connectivity solutions.
Then, in the beginning of June, Broadcom did exactly that, announcing that it will exit the mobile baseband business. This is estimated to result in an annual reduction of expenses of roughly $700 million, and Broadcom's share price responded accordingly, rising over 20% in the days following the announcement. But what will become of Broadcom's connectivity business, which formed the bulk of the mobile and wireless revenue?
Three buckets of connectivity
Broadcom's CEO Scott McGreggor has described the connectivity business as comprising three buckets. The first of these is high-end mobile phones and tablets. The second is mid-range and low-cost phones. The third is non-cellular, such as printers and Internet of Things appliances.
Broadcom has traditionally been strong in the high-end handset connectivity market, supplying both Apple and Samsung, who can afford to pick and choose among the best components. As for the non-cellular connectivity bucket, McGreggor called it "a very rich environment" in which Broadcom has a very good position. Since neither of these segments were associated with Broadcom's baseband business, it's to be expected that they will continue to develop and won't be affected by Broadcom's exit from baseband.
To protect and increase
Broadcom entered the baseband market for two main reasons. The first was to increase revenue, since baseband, and LTE in particular, is currently one of the largest growth opportunities in technology. Broadcom's second reason was an attempt to protect its connectivity business in low- and mid-tier phones, and it's here that the connectivity business is likely to suffer.
In low- and mid-tier phones, one supplier usually provides both the baseband and the connectivity solutions. According to the management of Marvell (NASDAQ:MRVL), which has had more success than Broadcom in entering the LTE market and is now in the No. 2 position, there is a 100% attach rate of connectivity solutions to baseband sales. Marvell CEO Sehat Sutardja described this colorfully by saying that if there's "anything wrong with the handset, [customers] just want one supplier to choke."
Broadcom estimates revenue from this part of its connectivity business at $500 million-$800 million per year. Management has stated that some of the losses might be offset by baseband partners such as Spreadtrum, who might win baseband sockets and take Broadcom's connectivity with them. However, if Marvell's Sutardja is right, this part of Broadcom's connectivity business will see some major losses in the coming year.
Several analysts have recommended that Broadcom exit all wireless-handset related segments, but it doesn't look like that's going to happen. McGreggor stated that connectivity remains a healthy business, and that the company is not interested in selling it off. Instead, Broadcom plans to merge its connectivity and broadband segments, citing strong synergies between the two as justification.
And maybe that points to the conclusion of this story. Management has said that unlike its baseband business, connectivity is modular, in that parts can be taken out or replaced without affecting the whole. Broadcom's low- and mid-tier handset connectivity segment, which was tied most closely to the baseband program, will likely suffer now that Broadcom is out of baseband. But the other two segments will continue, and might even prosper within a smaller, more profitable Broadcom.
Srdjan Bejakovic has no position in any stocks mentioned. The Motley Fool owns shares of 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.