A little while back, an analyst from BMO Capital Markets downgraded shares of Qualcomm (NASDAQ:QCOM) on checks suggesting that Samsung's (OTC:SSNLF) smartphone shipments were falling a bit short for the quarter.
With Samsung's CFO having recently made a statement suggesting that the second quarter didn't go all that well, the question now becomes whether Samsung's weakness spills over to Qualcomm, for which Samsung is a large customer.
If it's share loss to Apple, then probably
One possible explanation for Samsung's shortfall is possible share loss to smartphone giant, Apple (NASDAQ:AAPL). Note that while Apple is a large customer of Qualcomm's, there are two principal factors that would make share shifts from Samsung toward Apple at the high end unfavorable to Qualcomm:
- Royalty per device is likely lower. Samsung manufactures its own handsets, and as a result it pays a percentage of the selling prices of those devices to distributors/carriers to Qualcomm. Apple, on the other hand, enjoys a licensing loophole in which the royalty is paid based on the price that Apple pays its manufacturing partners rather than the price that Apple sells the phones to the end users/carriers for. Put simply, the royalty rate for a high end Samsung phone is likely materially higher than that of a high end Apple phone.
- Chip content is lower. As detailed in my prior article, Samsung's flagship Galaxy S5 uses a lot of Qualcomm silicon content including integrated apps processor/baseband, transceiver, audio CODEC, envelope tracker, and power management IC. The iPhone 5s, in contrast, uses a discrete cellular baseband (not an integrated apps processor/baseband, which is likely more expensive) and an audio CODEC from Cirrus Logic. Qualcomm simply has more silicon inside of a flagship Samsung phone than a flagship Apple phone.
So, if it turns out that Apple is gaining share at the high end on Samsung, then Qualcomm could see a negative revenue impact. If Samsung is merely losing share to other Android vendors, then the situation is pretty neutral for Qualcomm as LG, HTC, and other high end players use similar silicon from Qualcomm.
If the high end device market is simply slowing down or seeing average selling price erosion, then Qualcomm gets hit on the royalty side of things (as these royalties are usually based on device selling price). It's a bit trickier to call on the chip side of things.
Low end phones are a source of strength, not weakness
Although the high end may be a weak-spot for Qualcomm, it is important to not underestimate the power of the low end in driving Qualcomm's business. The growth in low end 3G and the beginnings of the LTE ramp are at the expense of 2G devices that did not bear royalties. This means that while blended average selling prices for royalty calculations will go down, the sheer total number of units that bear royalty goes up.
On top of that, in the low end of the handset market, Qualcomm is well ahead with its LTE solutions, capturing about 80% share of LTE platform solutions among the China handset vendors with its Snapdragon 400 solution.
Keep in mind that despite the fact that the Snapdragon 400 is a lower end apps processor (and thus lower priced) than the Snapdragon 800 that goes in the high end, attach rates for other components like connectivity combo chips are very high for the apps processor vendor, driving potentially increased content share. The smartphone OEMs playing in the low end don't want to "mix and match" components -- they want the platform to be as cheap as possible since the competitive pressures are high and margins relatively thin.
The negative here is that while Qualcomm has a virtual monopoly on high end smartphone platforms, there is competition in the 3G market (MediaTek is a particularly fierce competitor)
Foolish bottom line
If Samsung's troubles are reflective of the overall smartphone market, then Qualcomm -- which is very dependent on the success of cellular devices -- will be negatively affected. Further, a mix shift from Samsung to Apple would also likely be a negative.
That said, Qualcomm is likely to see an offset to that as the low end of the market moves toward LTE, where Qualcomm would not only benefit on the licensing side of things (most LTE phones are LTE and 3G multimode so Qualcomm gets paid for its full suite of patents), but from the chip side of things as well considering its LTE modems are well ahead of those from competitors such as MediaTek and Marvell.