Can Qualcomm Sustain Its First Mover Lead?

Oct.24.13 | About: Qualcomm Inc. (QCOM)

Qualcomm (QCOM), one of the leading providers of wireless technological solutions, has been quick in understanding the importance of the long term evolution, or 4G LTE, network. After dominating CDMA technology in the chipset market, the company is focused towards the LTE baseband. Qualcomm has a monopoly in this market, with a small presence of other chipset manufacturers. The company reported 35% year-over-year revenue growth in the third quarter of fiscal year 2013, and its chipset division posted 47% year-over-year growth.

Dominant Position LTE baseband

LTE network is among the fastest growing technology, with growth in LTE deployments across the globe. As per Global Mobile Supplier Association, or GSA, report, currently 213 network operators worldwide have launched commercial LTE operations in 81 countries, and by the end of this year, this figure is expected to increase to 260 operators in 93 countries. Growth in LTE rollouts has resulted in a rise in LTE subscribers, leading to growth in 4G LTE enabled handsets. As per the GSA forecast, LTE handset unit sales are expected to reach 494 million in 2015, which represents a 44% CAGR from 2013 to 2015.

Qualcomm's dominance in the LTE baseband market can be attributed to its products' compatibility with the different network modes and bands.

The company took first mover advantage in LTE baseband, and with its continuous R&D efforts, Qualcomm has gained a technological lead in LTE solutions. Qualcomm became the first chip manufacturer to integrate a LTE modem into its mobile application processor successfully, and with a 97% revenue share in the LTE baseband market in the first quarter of 2013, the company is commanding a monopoly in the market. This denotes strong relationships with almost all top-tier global handset manufacturers, which are using Qualcomm LTE solutions.

Qualcomm is already into its third generation of LTE products, with its baseband chip named Gobi providing support for all seven global network standards with multiband compatibility. The company became the first player to provide carrier aggregation LTE Advanced solution in its Snapdragon 800 processor integrated with third generation Gobi LTE modem. Carrier aggregation technology provides high data speed through increasing the transmission bandwidth by combining the carriers. In the initial phase, LTE Advanced smartphones will combine two 10 MHz carriers, enabling peak data rates of 150 Mbps. Qualcomm's third generation LTE products have been adopted by almost all the big handset manufacturers worldwide, and with the carrier aggregation option, the company is giving the true capabilities of 4G technology.

Click to enlarge

Source: Qualcomm Technologies

Where the competitors stand in LTE

Qualcomm is already in its third generation in the LTE segment, and competitors are stepping up product development to close the gap. Leading the race is Intel (INTC), which announced its first multimode XMM 7160 modem that is compatible with 15 of the 40 LTE bands globally. Multimode LTE chipsets allow device users to benefit from compatibility in different network bands and allow users to switch automatically from 4G to 3G or 2G, when required. This chip will give Intel an edge over its current single mode LTE chip offering and will help close the LTE market gap with Qualcomm. Intel started shipping this chip with its first design win for the recently launched Samsung Galaxy Tab 3 10.1 featuring Intel Atom Z2560 processor. XMM 7160 LTE baseband will give direct competition to Qualcomm's LTE Gobi chip, but we believe Qualcomm still holds an upper edge on certain parameters. For example, XMM 7160 is a discrete chip that has yet to be integrated with Intel Atom processor, while Qualcomm has already integrated its Gobi chips with its Snapdragon 800 processor.

Entry into multi-mode LTE baseband will give Intel more design wins, thus closing the gap with Qualcomm. The company recently released its third quarter results, which showed revenue growth of 5% quarter over quarter. By increasing its presence in the LTE baseband market, Intel can boost in its top line growth, thus offsetting the negative impact of the declining PC market.

Other companies following Intel in the LTE baseband race are Broadcom (BRCM) and MediaTek, which are planning to launch LTE chips next year. Broadcom has been mobilizing resources for developing a LTE chip in house, but with the recent acquisition of Renesas' LTE assets, the company has taken lead in launching its first ever multimode, multiband LTE system on chip, or SoC, next year. Major carriers including AT&T in the U.S., Vodafone, Orange, and EE in the U.K., and NTT DoCoMo in Japan have already validated this chip.

MediaTek, which has been giving tough competition in mid to low value handsets, holds 10% share in the overall baseband market. The company will launch its first SoC, which will support LTE, by the first quarter of 2014. Although it will take time for MediaTek to match Qualcomm's capabilities. With MediaTek's strong presence in China and its compatibility with China Mobile's upcoming 4G TD LTE network, it is expected to benefit from the carrier's huge subscriber base and transition to a 4G network.

In addition to Broadcom and MediaTek, Nvidia (NVDA) is also planning to enter the LTE market with its Tegra 4i chip, which is currently under carrier validation from AT&T. Once the chip is certified, it will be crucial for Nvidia to get design wins for its new chip. The 4G LTE market is just beginning, and with launch of carrier validated Tegra 4i processor, Nvidia can expect growth potential for its Tegra processor business.

Is the growth sustainable?

Its extensive product line in the LTE market has placed Qualcomm way ahead of its competitors. The company is already into its third generation LTE solution, and therefore it will take time for its competitors to close the gap. However, this lead will eventually reduce in the future, due to the growth in the number of players in the market.

Qualcomm not only manufacturers chipsets, but it also licenses its technology to other chipset manufacturers for one time licensing fees. The company is a leading developer of Code Division Multiple Access, or CDMA, technology, which facilitates communication between mobile devices and wireless towers. In addition to this, the company also gives licenses of Orthogonal Frequency-Division Multiple Access, or OFDMA, technology, which is used in LTE and WiMAX networks. Therefore, Qualcomm not only charges one time licensing fees from chipset manufacturers but it also collects some percentage of handset manufacturers' average selling price of each device sold as royalty. This manufacturer licensing business model has been a key growth driver for the company. This is a high margin business, as there is no manufacture involved in revenue generation. Qualcomm's licensing division had contributed 33% of its total revenue with operating income margin of 88% in 2012.

Average selling price, or ASP, plays a key role in determining the revenue from royalties. The company may face decline in royalty revenue as ASP is expected to come down due to growth in the mid to low priced smartphones sales in emerging markets. We believe that its impact will reduce in the long term as the company expands its patent portfolio, resulting in growth in the licensing revenue.

Conclusion

Qualcomm's strong presence in the LTE market is expected to sustain until competitors establish competitive products. The company has 450 LTE devices in the pipeline this year that will use Qualcomm's LTE solutions. Strong relationships with handset manufacturers combined with its third generation LTE solution will help in sustaining revenue growth in the future.

Qualcomm is among the most cash-rich semiconductor companies, with a reserve of $30 billion at the end of the third quarter of this year. Therefore, in a bid to return cash to shareholders, the company recently announced a new $5 billion share repurchase program. This program will replace the existing $5 billion program announced in March this year, and since July 24, 2013, Qualcomm has repurchased 40.1 million shares of common stock for approximately $2.7 billion. Therefore, this new share authorization will provide significant value to investors.

Qualcomm is currently trading at a 12 months trailing P/E of 18.29, and its forward P/E for the next fiscal year is 13.94, which denotes growth in the company's earnings contributed by the business growth and share repurchase program. In addition to this, Qualcomm has a low five year expected PEG ratio of 0.90, which substantiates a rise in the earnings. These valuation metrics are supporting the company's growth potential, which is expected to give significant return to investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Fusion Research is a team of equity analysts. This article was written by Rohit Gupta, one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.