Broadcom’s (NASDAQ:BRCM) stock price has declined by more than 20% since the company reported lower growth in its Q2 2013 earnings and guided a bleak outlook for Q3 2013. Speculation regarding Apple (NASDAQ:AAPL) and Samsung (PINK:SSNLF), which together account for 30% of its revenue, either shifting to competing products from Qualcomm (NASDAQ:QCOM) or start making their own connectivity chips is also responsible for the negative sentiment around Broadcom.
Though Broadcom continues to witness strong growth in its broadband and infrastructure business, it wireless division slowed down in Q2 2013 on account of lower revenues from the baseband business. It 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, Broadcom accounts for only 3.4% of the baseband and application processors market.
Broadcom derives more than 45% of its revenues from the mobile and wireless division and thus its stock price is highly sensitive to any adverse development in the mobile market. While we agree that Broadcom’s short-term growth will slow down, we remain positive on its long-term outlook.
In this article we highlight the main factors that have eroded investor confidence in Broadcom’s wireless division.
Broadcom Is Losing Share To Qualcomm In Connectivity Solutions
Broadcom recently lost a number of low cost smartphone sockets to Qualcomm, including the HTC One Mini, Samsung Galaxy S IV Mini, and the Motorola X. However, in its recent earnings call, Broadcom announced that its connectivity market share remains stable and it witnessed strong growth in the division in Q2 2013. Additionally, it saw sequential growth in discrete connectivity driven by technology leadership and new standards, like 5G Wi-Fi and bluetooth low energy.
The company claims that it won designs from new customers that offset the loss of a few handsets. Last year Broadcom expanded its product portfolio with 5G Wi-Fi smartphone chips and NFC quad-core chips, which targets growth in mass market mobile phones as well as high-end mobile phones and devices. Broadcom accounts for approximately 75% of the wireless connectivity space on LTE handsets. 
Broadcom spends around $1 billion every year as R&D expenditure for its overall wireless space with $400 million dedicated solely for its wireless connectivity business. In addition to its strength in connectivity technologies – 5G Wi-Fi and NFC – Broadcom is investing in emerging growth opportunities in nascent market for Internet of things and wearables. We believe the company will continue to retain its market share in connectivity solutions.
However, if Broadcom’s market share falls below 25%, there will be close to 10% downside to our price estimate. Apple switching over to Qualcomm for the connectivity chip in the upcoming iPhone 5 can be one such scenario where Broadcom’s market share declines. Apple has a long history of using Broadcom’s connectivity chips for its products.
Material Benefits From LTE Not Likely To Materialize Before 1H 2014
Broadcom announced its first LTE-compatible baseband chip earlier this year. It claims it to be 35% smaller compared to current products, making it the industry’s smallest 4G LTE chip in the market. The smaller chip size not only makes it cheaper to produce but also more power-efficient. Broadcom expects LTE to be a major growth driver for its baseband business but does not anticipate any significant revenues before the second half of 2014. The market anticipated the chip to start production much earlier than that and we think that this was one of the main reasons for the decline in Broadcom’s stock price.
Of the various technologies that are driving the market currently, LTE is seeing the strongest growth as carriers around the world are shifting to the new standard for wireless communication. The LTE leadership has allowed Qualcomm to command the majority of the smartphone market so far. Qualcomm was the first company to come out with an LTE modem as well as an applications processor with an integrated LTE modem.
Broadcom does not have a large customer base for its 3G business and pointed weakness in the same to be the primary factor behind lower wireless revenues in Q2 2013. 3G is weakening as the LTE platform gains traction. Nevertheless, with continuous improvement in its product portfolio, Broadcom has managed to increase its market share in the last few years. It is focusing on expanding its customer base as well as the number of models which it designs.
Though we agree that by the time Broadcom’s LTE chipsets hits the market Qualcomm’s technology will be steps ahead, we continue to believe that LTE compatibility will help Broadcom expand its penetration in the baseband market. Broadcom expects its AT&T ADAPT certification to complete by the end of this year and is in talks with other carriers as well.
In addition to LTE compatibility, Broadcom’s focus in the low-end Android smartphone market will help increase its foothold in the baseband market. Its success in low-cost handsets helped position it among the top four players in the baseband and smartphone application processor market.   The Android OS accounts for around 75% share of the global smartphone market.  Android also accounts for a majority share of the low-cost smartphone market that is expanding at a rapid pace, primarily fueled by growing demand from emerging economies.Notes:
- Broadcom: Unloved And Undervalued, Shares Have 30% Near-Term Upside, Seeking Alpha, July 29, 2013 [↩]
- Qualcomm, MediaTek and Intel Together Held Three-Fourth of Cellular Baseband Revenue Share in 1H 2012, Strategy Analytics, October 31, 2012 [↩]
- Qualcomm Maintains Lead in Smartphone Apps Processor Market, Cellular-News, January 11, 2013 [↩]
- Android Marks Fourth Anniversary Since Launch With 75% Market Share in Third Quarter, IDC Press Release, November 1, 2012 [↩]