Every so often, an industry experiences a secular change that has the potential to offer investors huge returns. We have seen this in cloud computing and social networking. And now, a new industry dynamic offers investors the potential for great returns.
The transition to 4th generation networks, also known was long-term evolution (LTE) is occurring rapidly in the United States, as well as other regions, such as Europe. The global LTE market is expected to grow to $262.05 billion in spending by 2015, representing annual growth of over 158% from 2010 levels. As such, firms that can capitalize on this secular development should see their profits and stock prices rise nicely as they sell into this expanding market. Below we identify 6 stock that are poised to ride the LTE wave.
Qualcomm is one of the largest semiconductor companies in the world, with a presence in each of the major smartphone platforms. But, in addition to its chips, Qualcomm is also a major supplier of network chips. With its strong patent portfolio, Qualcomm earns a steady stream of royalty income from its 3G CDMA standards. But, Qualcomm also holds a commanding position in LTE patents, owning 22% of that market. As LTE networks are built out across the world, Qualcomm will benefit not only from an increase in the number of chips it can sell, but from an increase in royalty income as well. While Qualcomm is not the only company wireless company with a patent portfolio to collect royalties from, we chose not to include companies like InterDigital (IDCC), for whom patents are their only line of business.
In addition to benefiting from the overall growth of the LTE market, Qualcomm will benefit from the newly released iPad, which has built in LTE connectivity. History has shown us that Apple (AAPL) can popularize virtually any trend or feature, and it is very possible that the iPad will accelerate LTE adoption even more (Note: We did not include Apple in this list because we chose to focus on companies for whom LTE is a prime business. For Apple, the inclusion of LTE networking is meant to drive hardware sales). Qualcomm will benefit from LTE iPad sales on two fronts. As the LTE chip supplier to Apple, Qualcomm is estimated to earn between $4 and $5 of profit on every LTE iPad sold, as well as earn $10-$15 in royalty income. Demand for the new iPad is strong, with Apple already selling out of all iPad's slated for pre-order. The Reuters average price target on shares of Qualcomm is $69.62, which represents upside of 9.37% as of this writing. However, it is possible that the average will be revised in the days and weeks to come as analysts adjust their models and estimates to account for the impact of the iPad.
While Qualcomm will be one of the prime beneficiaries of LTE adoption due to its sheer size, it is not the only semiconductor company that can benefit from the LTE iPad, and the growth of the LTE market as a whole. Avago and Silicon Motion can benefit as well, and due to their smaller size, it takes less to "move the needle" for these companies. Avago has a market capitalization of just under $9 billion, while Silicon Motion has a market capitalization of almost $570 million.
Avago is expected to win RF share in the iPad, as well as more 3G design wins. Avago had essentially no presence in the iPad 2, so the inclusion of LTE in the new iPad should be seen as an incremental positive for the Singaporean company. The Reuters average price target for Avago is $41.19, which represents upside of 12.02% from current levels as of this writing.
Silicon Motion is a Taiwan based semiconductor company that sells LTE chips, similar to Qualcomm. What makes Silicon Motion appealing is its wide presence at Samsung, arguably the second strongest player in the smartphone industry after Apple. Samsung has shown a reluctance to utilize Qualcomm's products on the same scale as its competitors, perhaps due to a desire to not chain itself to Qualcomm (This is similar to what PC manufacturers do with AMD so as not to give Intel total control of the market). Silicon Motion is winning share at Samsung, with its LTE chips set to be in 11 models. The company currently has a presence in 6, and is set to be in 5 more. Given that Samsung has shown that is currently the only company to be at least somewhat competitive relative to Apple, increasing sales at Samsung will boost Silicon Motion's bottom line nicely. Currently, the Reuters average price target for Silicon Motion is $30.40, representing upside of 65.15% as of this writing.
It is crucial to remember that LTE chip companies are not the only ones poised to benefit from the boom in LTE. While it is true that carriers are investing billions in designing and building their LTE networks, those networks will eventually be field with millions and millions of paying customers. We are choosing to focus on 3 carriers in particular: AT&T, Verizon in the United States and Vodafone internationally. We chose to leave out the other 2 American carriers, Sprint (S) and T-Mobile, for several reasons. While we are bullish on Sprint, and have written about it extensively before, our bullishness is due to reasons other than Sprint's LTE network buildout. And T-Mobile's 4G plans are clouded by the turmoil over its place in Deutsche Telekom's future.
The new iPad is compatible the LTE networks of both AT&T and Verizon, and there are rumors of a Sprint version. And both AT&T and Verizon are expected to benefit from the LTE iPad (although Verizon is expected to benefit more in the short-term due to its wider LTE network). With as many as 30% of iPad purchases set to be LTE models, AT&T and Verizon are poised to generate, at a minimum, hundreds of millions in LTE iPad revenue alone. It is estimated that for the 2 companies, every LTE iPad means about $45 of new monthly revenue. Given Apple's ability to popularize new features, it is likely that LTE iPads will drive increased adoption of LTE amongst other tablets. The current Reuters average price target for Verizon stands at $39.72, representing upside of 1.59% as of this writing. For AT&T, the Reuters average price target is $32.33, representing upside of 3.69% as of this writing. It should be noted that many investors choose AT&T and Verizon for income, not capital appreciation, and thus see new sources of profits not in terms of higher earnings per share, but in the 2 companies' abilities to keep increasing their dividends.
We chose to include Vodafone in this list not only for its 45% stake in Verizon Wireless, and the dividends that the company may receive from that stake. It should be noted, however, that these dividends are not recurring, and occur when it is determined that they are necessary for Verizon to pay its own dividends and deleverage itself. Vodafone is the 2nd largest wireless company in the world, with 391 million subscribers as of September 2011, behind only China Mobile (CHL). Vodafone has an unparalleled international presence, with operations all over the world, including the US (Verizon Wireless), Europe, India, and Africa. The company is the current LTE leader in Europe, and has shown itself to be the most aggressive when it comes to releasing LTE devices. While it is true that the buildout of LTE networks has been slower in Europe than in the United States, we fully expect that in the long run, Europe will build out LTE on the same scale as the United States. In addition, Vodafone's deep international presence will allow it to capitalize on the eventual creation of LTE networks in places like India and Africa. But this is a more long-term situation than in Europe. Currently, the Reuters average price target for Vodafone's ADR's is $34.06, representing upside of 28.14% as of this writing.
The 6 stocks we profiled above are by no means the only companies that will benefit from the LTE wave. However, they are the 6 we feel are the best investments at the moment. LTE equipment makers like Ericsson (ERIC) and Alcatel-Lucent (ALU) have more uncertainty. Competition from Huawei is intense, and both Ericsson and Alcatel-Lucent are facing pressure. We hesitate to recommend shares of either company until we see a clearer picture of where the companies stand in the marketplace. Alcatel-Lucent just recently returned to profitability since the 2006 merger that created it, and we would like to see better financials before investing in it, specifically the company's plans for consistent profitability. As for Ericsson, the company's margins have suffered as it tries to hold its market share. That being said, as LTE buildouts expand, and the company is no longer tied to Sony-Ericsson, Ericsson's financial profile should improve. We will wait until Ericsson's next quarterly earnings release to see where the company stands.
The creation and utilization of LTE networks, both in the United States and abroad, will be a multi-year trend that is just beginning. And the 6 companies we highlighted are all poised to benefit. The LTE iPad should spur increased LTE adoption, leading to higher revenues and profits for the companies that sell LTE chips, own patents on the underlying technology, or actually operate the networks. We have always been firm believes in investing in specific trends, such as rising agricultural demand. And the LTE wave is no exception. Over the next several years, LTE networks will truly take shape, and these 6 companies are sure to benefit.
Additional disclosure: We are long QCOM via a mutual fund that gives it a weighting of 1.65%. We are long T and VZ via the SPDR Dow Jones Industrial Average ETF.