Broadcom's (BRCM) strong performance in its broadband and infrastructure business in Q1 2014 was offset by a decline in its connectivity business. Intense competition in the connectivity domain and increasing investment for building its baseband portfolio has impacted Broadcom's growth in the last few quarters. Though the company expects its wireless business to decline in the current quarter as well, it believes that the business will grow in the second half of the year, backed by LTE certification, increasing penetration of 5G Wi-Fi and other multiple technology transitions. (Read Our Earnings Article)
Broadcom provides baseband solutions for EDGE, 3G and 4G systems as well as multimedia and application processors for mobile phones and handheld devices. Though it remains the leader in the mobile wireless market (33% market share), the company accounts for only 2% of the baseband and application processors market. The two divisions combined account for approximately 37% of Broadcom's valuation, as per our estimate.
In the last few years, Broadcom has taken a number of steps to increase its penetration in China, the world's largest smartphone market. China accounts for more than 90% of Broadcom's exports; these exported semiconductors are shipped to China both for re-export and national sale.  The company aims to become the best semiconductor solutions provider in the Chinese market, making the region its largest market outside America. The issuance of 4G licenses, promotion of the Broadband China project, and popularization of HD videos provide significant growth opportunities in the region.
In this article we discuss why an increasing focus on China can help expand Broadcom's connectivity and baseband applications business.
Our price estimate of $38 for Broadcom is at a significant premium to the current market price.
China Is The Largest Smartphone Market; Low-Cost Phones Driving Demand
In Q1 2014, 449 million mobile phones (feature and smartphones) were sold, 3.9% higher compared to Q1 2013. Smartphones accounted for 62.7% of total mobile shipments in the quarter, with 40% of the demand coming from China. 
With more than 500 million smartphone users, China is the world's largest smartphone market. Rising demand for low-cost phones is one of the key factors driving strong mobile sales in the region. According to ABI Research, smartphones with a price point of $250 and below (before carrier subsidies) will account for 46% of global smartphone shipments by 2018 compared to 28% in 2012.  Much of the low-cost smartphone growth is being driven by rising demand from emerging economies with China leading the pack, so far.
The Chinese government recently issued 4G licenses to its telecom providers - China Mobile (NYSE:CHL), China Telecom (NYSE:CHA) and China Unicom (NYSE:CHU) - in the TD-LTE network. Only a handful of countries, including China, have adopted this standard for its 4G, and the same is expected to increase demand for LTE-enabled smartphones in China this year. 
Focus On China To Increase Broadcom's Baseband and Application Processors Share
Given the growth in smartphone sales in China, Broadcom has been focusing on building relationships with low-cost smartphone makers in the region. The company has a wide range of partnerships in China, including that with China Mobile, China Unicom, China Telecom, Huawei, ZTE, Lenovo, Alibaba (ABABA) and Star-Net. It is keen on delivering more bandwidth than ever to China through connectivity chips in smartphones and tablets as well as household devices.
- Integrated application processors are cheaper: Broadcom's integrated turnkey products are important drivers for the company's growth in China. Baseband-integrated application processors are cheaper for handset makers to use in mobile phones compared to standalone processors. The low-cost handset market is increasing at a rapid pace, and users are demanding a better mobile experience over time. Broadcom's integrated turnkey products allow smartphone manufacturers to optimize their bills of material and offer an affordable feature-rich handset.
- New Turnkey LTE Platform: Broadcom recently launched its fifth-generation turnkey LTE platform, which targets the sub $300 smartphone market. Products will start sampling in the first half of 2014. We believe that the addition of LTE will help Broadcom leverage growth opportunities created by the 4G LTE rollout in China. Till now, Broadcom products for entry-level smartphones covered 3G technology. Last year, Broadcom collaborated with China's TCL Communications and K-Touch, which use its dual-core 3G platform for their Android-based smartphones. At least 44 engagements with Broadcom's reference designs in China were witnessed last year, and with the addition of 4G LTE capabilities, the company is set to get more designs this year (Broadcom: Focusing On LTE And Network Infrastructure). Broadcom has also managed to sustain its leadership in LTE smartphones, featuring its combo connectivity chip in 75% of all LTE phones shipped in 2013. 
- Competition from other players can limit growth potential: Broadcom faces intense competition from Qualcomm (NASDAQ:QCOM), Marvell (NASDAQ:MRVL) as well as low-cost Chinese baseband suppliers RDS Microelectronics and Spreadtrum. Qualcomm accounts for approximately 95% of the global LTE baseband market, and generates approximately 50% of its revenue from customers in China.   Marvell is the leading provider of advanced TD-SCDMA technology (used for 3G) by China Mobile, the world's biggest telecom company in terms of subscribers.  RDA Microelectronics and Spreadtrum together ranked number two in baseband unit share terms in Q3 2013.  Though we expect Broadcom to gain share in the Chinese baseband and application processors market, we believe that the intense competition will limit its growth potential.
Disclosure: No positions.