After a relatively lackluster performance for a major part of the year, Qualcomm’s (NASDAQ:QCOM) shares have risen steadily to near all-time highs on a strong set of Q3 FY13 results announced last month. Going into the earnings, it was a major concern that the semiconductor giant’s high-margin licensing fees and, to an extent, chipset sales would be impacted by a possible saturation in the high-end smartphone market and a growing mix of emerging market sales. While the Q3 results showed sustained strength in Qualcomm’s Snapdragon business, what truly beat expectations was a stronger-than-expected rise in ASP (average selling price) levels of mobile chipsets as well as mobile devices. While device ASPs were up by a strong 6% at the mid-point of guidance, chipset ASPs rose 8% sequentially as the sales mix shifted more towards the high- and mid-tier products.
The ASP increase shows that the ongoing LTE transition as well as carrier subsidies in developed markets are more than offsetting any impact from the growing proportion of emerging market sales. Going forward, as the sales mix shifts to emerging markets, there could be a downward pressure on ASPs, but the impact should also be offset by an equally rapid smartphone transition taking place in many of these markets. If we look at the current feature phone prices and compare them to smartphones even at the lowest end of the spectrum, the price differential is meaningful enough to give ASPs an uplift as the transition picks up pace. On the other hand, what should be a bigger concern going forward is Qualcomm’s ability to collect royalties from some of the local manufacturers in the emerging markets such as China, where it has historically faced challenges especially in the TD-SCDMA market.
From a chipset perspective, the lack of support for low-end TD-SCDMA and EDGE chipsets may not be a big hindrance to Qualcomm’s future growth since China will soon be transitioning to 4G LTE, the licenses for which are likely to be given out by the end of the year. In the near term, we see Qualcomm increasingly benefiting from a global ramp-up of 4G device sales as it leverages its huge patent portfolio and early LTE lead in chipsets to keep competition at bay. Longer term, however, there is likely to be pressure on margins and mobile device ASPs, as the mix shifts to emerging markets and LTE competition catches up. Keeping these factors in view, we maintain our $70 price estimate for Qualcomm which is about 5% ahead of the market.
Emerging Markets Will Drive Qualcomm’s future growth
The smartphone market has shown significant growth in recent years. Gartner estimates that almost 700 million smartphones were shipped worldwide last year, a growth rate of more than 43% over 2011. With smartphones rapidly cannibalizing feature phone sales, the growth is likely to sustain itself over the next few years. Most of this future smartphone volume growth is likely to come from the emerging markets such as China and India where 3G/4G penetration is still very low and carriers are intent on driving data usage through smartphones. According to IDC, more than 210 million smartphones were sold in China last year, giving the country a share of almost 30% of the world market and leaving the U.S. far behind. With a billion strong mobile subscriber base and carriers increasingly trying to transition their huge 2G base to 3G, China presents a huge opportunity for Qualcomm to not only gain from its chipset sales, but also earn a steady stream of licensing revenues. (see Qualcomm Introduces Three New Entry-Level Chipsets To Target Emerging Markets)
The biggest opportunity for Qualcomm here is China Mobile, which will transition from a home-grown TD-SCDMA standard to the more widely used 4G LTE technology over the next few years. China Mobile is not only China’s largest wireless carrier, but also globally, with a huge subscriber base of almost 750 million that overshadows Verizon’s by almost seven times. Given Qualcomm’s early lead in LTE and its relatively low presence in the earlier standard TD-SCDMA, China’s transition to LTE should give it not only a wider base to collect royalties from, but also to further its chipset market share.
However, an increasing mix of mobile phones sold in the emerging markets will see mobile ASPs fall, limiting the upside to licensing fees from such a scenario. We currently estimate that the 2G to 3G/4G transition will see 3G/4G penetration of mobile devices worldwide grow from about 50% currently to about 65% by the end of the forecast period. However, the increasing adoption of smartphones in emerging markets buoyed by the growing number of low-end affordable smartphone options could see 3G/4G penetration increase to about 80% by the end of our forecast period. Such a scenario would add a further 10% upside to our price estimate. However, if mobile ASPs fall to about $150 from the current level of $220 simultaneously due to growing emerging market mix, the upside to our price estimate would be limited to only about 6%.
Qualcomm’s LTE Superiority Preserves High-end Dominance
As for the high-end market, carriers are widely promoting the high-speed 4G LTE technology in the developed regions of U.S., Japan and South Korea. Qualcomm has taken a big early lead in this market, having come to market first with its LTE-capable baseband chipsets. Of the 47 million LTE-capable chipsets that were shipped last year, Qualcomm accounted for nearly 86% of the market. Q1 2013 saw the share increase to nearly 97%. While competitors have started bringing their first LTE basebands to market only recently, Qualcomm’s chipsets are in their third-generation already. This big early lead is not only a testament to the company’s superiority in 3G/4G connectivity solutions but also its ability to integrate these baseband capabilities onto a single app processor chip, both of which have helped it perform really well in the smartphone market so far.
However, competition in the LTE market is slowly growing with Samsung and Nvidia having made their Exynos and Tegra line of app processors LTE-compatible. But we expect Qualcomm’s technological superiority to help it hold fort in the near term. This could be seen in Samsung’s decision to launch the Galaxy S4 with Qualcomm’s chipsets for LTE markets despite having a LTE-compatible chipset of its own. While Qualcomm’s huge initial market share is likely to decline over time due to increasing competition, the overall growth in the LTE market should help offset some of that impact.