Sorting out Semiconductors: Who Benefits from Apple's New Products?

|
Includes: AAPL, AVGO, INTC, NVDA
by: Dhinesh Ganapathiappan

The semiconductor industry is packed with complex terminology and hundreds of large companies making various specialized products. Here is an overview of what these companies are doing, what devices they are producing chips for, and which stocks appear most favorable on Wall Street.

So what is a semiconductor? A semiconductor is basically the material that is used in Integrated Circuits, more commonly known as computer chips. The process of making a chip involves etching into a block of semiconductor material, usually silicon. Miniature circuits are created from the carving, which can perform the computing tasks that it is designed to execute.

In a sense, the chip is the brain of computing operations. There is a chip inside your computer, cell phone, DVD player, and numerous other electronic devices. The big names in the industry include Intel (NASDAQ:INTC), Qualcomm (NASDAQ:QCOM), and Texas Instruments (NYSE:TXN), but these companies represent just a portion of the industry that generated $259 billion of sales in 2006.

The next hot electronics product on the horizon is the Apple (NASDAQ:AAPL) iPhone. Apple’s foray into the handset market will likely shake up the marketplace thanks to its dominance in the consumer electronics arena. Many of the companies that are believed to be contracted for the components of the iPhone have also made parts of previous iPod models.

Broadcom (BRCM) boasts an expansive product portfolio including wireless networking, ethernet, digital television, DSL, cellular wireless, and VoIP. Early reports indicate that Broadcom will make the controller chip for the iPhone’s unique touch-screen. While this will undoubtedly help Broadcom’s standing in the industry and boost revenue, a teardown analysis by iSuppli reveals that this particular chip only contributes about $1.15 per unit sold to Broadcom, although it is possible that the company also plays a role with other miscellaneous semiconductors in the phone.

Marvell Semiconductor (NASDAQ:MRVL) is on tap to provide Wi -Fi functionality for the iPhone, which the iSuppli teardown reports should contribute $15.35 per unit sold to Marvell’s top-line sales. The company also makes a chip for the iPod that controls the hard disk. Shares of both Marvell and Broadcom have floundered lately, but still trade at hefty valuations even after recent declines. Their presence in the iPhone will likely aid their visibility in the industry and revenues, but will not necessarily translate into higher earnings due to thin profit margins. The semiconductor industry has been improving lately but both Broadcom and Marvell have a long way to go to become attractive investments.

Apple stands to reap the greatest rewards from the iPhone. The 4 gigabyte model of the iPhone costs Apple about $245.83 to produce, but the phone is priced at $499 – resulting in huge profit margins of over 50%. The 8 gigabyte version costs $280 to manufacture, but will be marked up even higher to $599 per unit. Apple has historically commanded high margins on its products, with the latest iPod model selling for $249, but costing $143.50 apiece.

The higher price points of the iPhone means that each unit sold will translate into a greater amount of profits for Apple, and as history has shown there are millions of loyal Apple junkies snatching up the latest products. A recent survey by Piper Jaffray showed that 84% of teenagers have heard of the iPhone and 25% indicated that they would buy one. For consistent earnings growth and distinctive product releases, Apple is a great investment to consider.

Another new Apple product with an array of semiconductors in play is the ‘Apple TV’ device. The Apple TV is Apple’s Trojan horse into your living room with the ability to download movies from Apple’s online iTunes music and video store and wirelessly transfer media from your computer to the Apple TV device. After connecting the Apple TV device to your television you can watch downloaded movies and listen to music from your iTune s library on your stereo with ease using an included remote.

The Apple TV uses an Nvidia (NASDAQ:NVDA) GPU (graphics processing unit) chip to produce the optimum visual experience. Nvidia is well known for its advanced graphics cards that are used in upscale desktop and laptop computers. Intel (INTC) will provide the CPU of the Apple TV, enhancing a partnership that began in 2006 when Apple computers first featured Intel processors instead of IBM (NYSE:IBM) chips. The Apple TV is currently selling for $299 and Apple has likely limited the benefit to either Nvidia or Intel, but both of these companies have reasonable valuations and make better investments with their diverse range of products and strong brands.

Semiconductor companies lack the flexibility of innovative companies like Apple that design prototypes which generate relentless buzz. Instead, they get squeezed by competition to win a bid into popular products in order to gain publicity and some profits. There is no guarantee that these companies will continue to be featured inside an Apple product, as Apple has been known to cut ties swiftly. PortalPlayer raised its prices for an iPod chip in 2006 and Apple opted to go elsewhere with its business, causing PortalPlayer stock to lose 70% of its value in a matter of months.

The struggles of the semiconductor industry show just how important it is to be unique and set yourself apart from the pack as Apple has expertly done. Copycats like Microsoft (NASDAQ:MSFT) have failed to replicate the success of products pioneered by Apple. Combined with a talented management team headed by Steve Jobs, the result is an $86 billion company trading at $100 per share with the sky as the only limit to ceaseless ingenuity and a rising stock price.

Disclosure: none