Yesterday, leading semiconductor provider for wired and wireless communications Broadcom (NASDAQ:BRCM) announced that it has engaged investment bank JPMorgan (NYSE:JPM) to explore strategic alternatives for its cellular baseband business, including a potential sale or wind-down. The company expects the sale or wind-down of its cellular baseband business to result in a $700 million reduction in annualized GAAP research and development (R&D) and selling, general and administrative (SG&A) expenses, including $100 million in estimated reductions in stock-based compensation. Broadcom plans to originally reinvest around $50 million of these savings on an annualized basis into projects in the broadband, infrastructure and connectivity businesses.
A substantial increase in R&D expenses for developing cellular baseband products has lowered Broadcom’s mobile and wireless operating income in the last two years. The baseband market is quite R&D intensive, and Broadcom has spent over $3 billion on cellular baseband related R&D since 2007 without earning any profit.
The mobile and wireless segment incurred an operating loss of $32 million in Q1 2014. Broadcom earns over 40% of its revenue from this division, which can be split into two parts – connectivity solutions and baseband solutions. With a 33% market share, Broadcom has been the leader in connectivity solutions for many years and, despite losing some low-cost smartphone sockets to Qualcomm (NASDAQ:QCOM), its market share in the segment remains stable.
On the other hand, Broadcom accounts for less than 3% of the mobile baseband and application processor market. Though the company estimated its wireless business to decline in Q2 2014, it expected growth to accelerate in the second half of the year, backed by the LTE certification of its mobile devices. In its latest earnings call, Broadcom indicated that its 4G business is tracking its road-map milestones and that it is engaged in talks with various customers, which should translate into multiple design wins later this year. Thus, Broadcom’s decision to dispose of this business came as a surprise to us.
Our price estimate of $38 for Broadcom is at a significant premium to the current market price.
Increasing Competition In The Baseband Market
With its decision to dispose of the baseband business, Broadcom joins other companies such as Texas Instruments (NYSE:TXN), Freescale Semiconductor (NYSE:FSL), STMicroelectronics (NYSE:STM) and Ericsson (NASDAQ:ERIC), which have in the past bowed out to stiff competition in this segment. Qualcomm, Intel (NASDAQ:INTC), MediaTek, Spreadtrum (NASDAQ:SPRD) and Marvell (NASDAQ:MRVL) are now the key players left in the baseband market.
According to Strategy Analytics, Qualcomm dominates the cellular baseband market with a 64% revenue share, followed by MediaTek and Intel which account for 12% and 8%, respectively. On one hand, Broadcom has been struggling to challenge Qualcomm’s dominance in the 4G long-term evolution (LTE) chip market (Qualcomm has a 95% revenue share), and on the other, it has lost market share to MediaTek in the low-cost smartphone market. Though Broadcom has had some success in 2G and 3G market, it has never really capitalized on its momentum with key vendors such as Samsung (OTC:SSNLF) and, back when it was a major player, Nokia (NYSE:NOK).
Declining 3G Business Lowers Margin
Broadcom’s 3G baseband shipment year-over-year growth fell from 193% in 2012 to just 4% in 2013. This can be attributed to intense competition in the 3G baseband market and maturity of 3G baseband technology. Strategy Analytics believes that the barrier to entry in 3G basebands is low now and, as a result, the market has seen rapid price erosion in recent quarters, leaving vendors with very little margin.
Delay In Production Of 4G LTE Chip
Of the various technologies that are driving the market currently, LTE is seeing the strongest growth, as carriers around the world increasingly shift to the new standard for wireless communication. The delay in production of its 4G LTE chip is one of the main reasons that Broadcom is struggling to gain a foothold in the baseband market. It acquired LTE-related assets of Renesas Electronics (OTCPK:RNECY) late last year, which speed up the production of its 4G LTE chips. The deal gave Broadcom access to a dual-core LTE SoC that was ready for volume production and was carrier-validated by leading global operators in North America, Japan and Europe. However, Broadcom’s technological roadmap is still considered to be behind peers like Qualcomm, MediaTek and Marvell Technology.
Disclosure: No positions.