The ongoing transition to 3G and 4G networks around the world gives Qualcomm (NASDAQ:QCOM) a lot of growth potential to tap into. While carriers in developed markets such as the U.S., South Korea and Japan are a long way ahead in terms of penetration of mobile broadband (3G/4G), a bulk of the emerging world is still accessing 2G services. Overall, more than 70% of wireless connections worldwide are on 2G, which leaves plenty of upside potential for sales of 3G/4G-enabled smartphones and their components such as baseband and app processors. There is, however, a big disparity between how far the developed and emerging markets have progressed in 3G penetration. While developed markets are a long way ahead, with some carriers done with the deployment of their nationwide 4G networks, emerging markets such as China have only about 33% of their subscribers on 3G.
With 3G penetration still very low in emerging markets and handset makers increasing their focus there as developed ones reach saturation levels, a bulk of the future demand for 3G/4G smartphones is very likely to come from such markets. Some carriers in emerging markets have also begun building LTE networks to tap the growing demand for data and mitigate the impact that the rise of Instant messaging apps and social media is having on their legacy voice and SMS services. China, which has grown to become the biggest market for smartphones, is looking to transition to 4G and has also handed out TD-LTE licenses to carriers. The biggest carrier there, China Mobile, is leading the LTE transition with 4G services already launched, albeit in select cities.
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Our current estimates for 3G/4G device sales assume that global penetration of mobile broadband connections will reach about 50% by the end of our forecast period. However, if adoption of 3G/4G services increases more rapidly as carriers in emerging markets such as China incentize data usage through smartphone subsidies, there could be 15% upside to our $72 price estimate for Qualcomm.
China Mobile’s 4G Transition To Boost Qualcomm
The transition to 4G in China is key to Qualcomm’s growth in the region. So far, Qualcomm’s revenue growth in China has been limited by the slow pace of 3G upgrades in the country, mostly due to China Mobile’s homegrown TD-SCDMA network. The carrier may be the largest in China and globally, with a subscriber base of over 760 million, but the carrier hasn’t been able to lead the 3G transition in the same manner as it has in 2G, thereby pulling back China’s overall penetration of mobile broadband. While China Mobile’s 3G penetration is less than 25%, the other two major carriers, China Unicom and China Telecom, have managed to convert almost half of their overall subscriber base to 3G. The biggest reason for China Mobile’s 3G lag has been its TD-SCDMA network, which is mostly incompatible with many of the popular smartphones available globally.
The transition to TD-LTE, which is a more widely used 4G standard, will help China Mobile convert more of its subscriber base to 3G/4G as well as allow Qualcomm to benefit from the sale of additional 3G/4G-compatible chipsets. Also, given Qualcomm’s relatively low presence in TD-SCDMA and early lead in LTE, a very large subscriber base in China Mobile that was virtually out of its addressable market earlier will now give Qualcomm a wider base of handset sales to collect royalties from.
Upside From Growing Global 3G/4G Penetration
In order to gauge the impact of growing global penetration of 3G/4G on Qualcomm, we take a look at the current penetration levels and the potential for growth in the coming years. According to GSMA Wireless Intelligence, 3G/4G connections accounted for only about 23% of the overall wireless base of 6.8 billion in 2012 – up from about 17% in 2010.  Going forward, it estimates that the overall wireless connections will grow at a CAGR of 7.6% over the next five years. Assuming an average growth of 4% after 2017, the number of mobile connections should grow to about 11 billion by the end of our forecast period (2020). Historically, 3G adoption has been slow since a bulk of the emerging world has hardly made the transition yet. As a result, the penetration of mobile broadband has increased to only 23% in 2012 in seven years since 3G’s debut. Going forward, however, we expect the increasing demand for data as well as smartphones to cause the penetration of 3G/4G connections to grow at faster than historical rates.
However, Qualcomm benefits not only from the number of new 3G/4G connections that are added every year (as a result of new device purchases) but also from the existing subscriber base upgrading their devices. We need to therefore have a historical perspective for the number of mobile broadband subscribers that upgrade their devices annually to estimate the long-term 3G/4G opportunity for Qualcomm. According to Qualcomm itself, over 936 million 3G/4G devices were sold in 2012 – almost double the number in 2008. Taking this into account along with the aforementioned growth in 3G/4G connections, we calculate that about 46% of 3G/4G subscribers upgraded their devices in 2012 – down from about 70% in 2009. Assuming that in the long run, every 3G user upgrades his or her device every four years on average, the percentage should decline to about 25% by the end of the decade as mobile broadband becomes more mainstream and proliferates in emerging markets.
We currently estimate that about 70% of mobile devices sold by the end of our forecast period will be compatible with 3G/4G – up from about 50% in 2012. Together with the long-term estimate of 25% for device upgrades, this implies that 3G/4G will grow to account for a little over 50% of global wireless connections by the end of our forecast period – up from 23% in 2012. However, rising data demand in China as well as other emerging markets means that 3G/4G penetration could increase much more rapidly. According to GSMA, 50% penetration for 3G/4G connections could be reached as early as 2017.  If penetration levels reach 60% by the end of the decade, 3G/4G device sales could account for almost 85% of the total device sales – about 15% ahead of our current estimate.
This could bring an additional upside of $8 billion to Qualcomm’s top-line by the end of our forecast period, as greater 3G/4G device sales lead to not only higher royalty fees but also additional chipset sales for the company. This could add another $20 billion, or about 15% to our valuation for Qualcomm. However, any aggressive growth in global 3G/4G penetration levels will be accompanied by stiff competition at the low end in emerging markets, pressuring ASP levels and potentially causing Qualcomm’s market share to take a hit. While Qualcomm has seen its 3G/4G chipset market share increase in recent years, primarily due to its stronghold at the high end in LTE-enabled smartphones, increasing exposure to emerging markets where low-end competitors such as MediaTek have been gaining in strength could cause share declines in the long run. If Qualcomm’s 3G/4G market share falls from about 66% currently to 60% by 2020, the upside could be limited to only 10%.Notes:
- The Mobile Economy 2013, GSMA Wireless Intelligence [↩]
- Half of all mobile connections running on 3G/4G networks by 2017, GSMA, November 2012 [↩]