Semis Waiting on an iPhone Tear-Down to Rip

by: Michael K. Dawson

Almost a year ago I wrote an article called “For Investors the SmartPhone War is Over.” My premise was stocks of companies in the mobile ecosystem will outperform the device makers going forward. Sort of like the old saying “the best way to make money in a gold rush is to sell the picks and shovels.” In many cases the component makers win no matter what SmartPhone you walk out of the store with. My theory worked out pretty well in 2010.

As a benchmark, I used the QFON SmartPhone index. It is an index that includes companies that are primarily involved in building, design and distribution of handsets, hardware, software, and mobile networks associated with the development, sale and usage of smartphones. I categorized the stocks by industry and created a spreadsheet with their stock returns. The component companies (picks and shovels) were the clear cut winners. Arm Holdings (NASDAQ:ARMH) +142%, Atmel (NASDAQ:ATML) +167%, OmniVision Technologies (NASDAQ:OVTI) +103% and Skyworks Solutions (NASDAQ:SWKS) +101% to name a few.

On the other hand, devices makers such as Research in Motion (RIMM) and Nokia (NYSE:NOK) had disappointing years down 13.9% and 19.7% respectively. Palm was subject to a take under by Hewlett Packard (NYSE:HPQ) for $6 per share. Google (NASDAQ:GOOG) experimented with being a device maker and didn’t fare well either, down 4.2%. Apple (NASDAQ:AAPL) was the obvious exception and I stated that in my article.

I have written about Qualcomm (NASDAQ:QCOM) many times (The Trend Rida). It is almost a given that Qualcomm will be providing the primary communication chip in the Verizon (NYSE:VZ) iPhone. That will be confirmed on Monday night when the first Verizon iPhones are delivered and someone “tears them down.” However, I think the big win will be if iPad2 and iPhone 5 use a combo GSM & CDMA chip. Qualcomm may be the only company that can deliver that chip. The tell will be when the iPad2 is announced – will there be two 3G models (GSM & CDMA) or one? Needless to say, that will be huge win for Qualcomm.

The new buzz is Near Field Communications (NFC). NFC will enable users to make purchases by waving the phone near a payment terminal. It actually extends beyond payments. Think about all of those loyalty cards in your wallet. Your phone essentially becomes an “e-wallet.” It is rumored that Apple plans to embed NFC in iPad2 and iPhone5 (Bloomberg). The company providing that chip wallet will “runneth” over.

I have identified four companies in the NFC space. I am sure there are others. Rest assured, Apple will only be using a provider that can produce millions of chips. Start-ups need to apply. NXP Semiconductor (NASDAQ:NXPI) is a name many may not have heard of, but it is a spin-off of Phillips. There are rumors that Apple has been testing NXP hardware for some time. Goldman Sachs ran NXP’s IPO last year and we know Goldman always has the inside scoop.

Broadcom (BRCM) bought NFC specialist Innovision Research last year. The company just announced a new NFC chip that sounds interesting. It is an ultra-low power chip that doesn’t draw power from the device’s battery (Phone Scoop). This is most likely too late for the iPad/iPhone, but should be kept on our radar. Matter of fact, after Broadcom’s disappointing earnings last week [see transcript] – this could be a good time to buy.

Samsung (OTC:SSNLF) also recently announced a new NFC chip (Phone Scoop). Apple and Samsung have a strong relationship. It is quite possible that Apple has been testing these parts long before the chips were announced. The fourth company I have identified is On Track Innovations (NASDAQ:OTIV). In my opinion, it is too small to be considered as a supplier to Apple. However, that won’t prevent it from running up on the buzz.

My money is on NXP being the provider for Apple’s NFC technology, but I would not count Samsung out.

Disclosure: I am currently long Apple, NXP Semiconductor and Qualcomm. I will most likely be adding Broadcom soon.