Qualcomm Benefits From China Mobile’s Likely Shift To Five-Mode Handsets

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Qualcomm (NASDAQ:QCOM) may be have some good news coming in from China, with rumors suggesting that China Mobile (NYSE:CHL) has reverted to its initial policy of procuring 4G terminals with support for both TDD- and FDD-LTE. At least two independent news reports from Brightwire and Marbridge Consulting have suggested that China Mobile will change its handset requirements to five-mode-only from May/June onwards, ending a brief reconciliation period for local players in which they were allowed to ship three-mode terminals as they looked to catch up with the more advanced five-mode technology. [1] [2] While the five-mode 4G terminals provide global support for TD-LTE, FDD-LTE, TD-SCDMA, WCDMA, and GSM, the three mode terminals leave out WCDMA and FDD-LTE, making them more suited for domestic use on China Mobile’s network.

If the rumors are true, it could be a big near-term advantage for Qualcomm, which was the first to launch multi-mode chipsets and is currently the market leader in LTE baseband shipments. Further, the fact that five-mode handsets carry higher royalties than three-mode should boost Qualcomm’s higher-margin licensing business. However, there is still a significant concern in the Chinese government’s anti-monopoly stance against Qualcomm, which could lead to lower royalty rates for the company in the country. We maintain a $73 price estimate for Qualcomm, about 5% below the current market price.

See our complete analysis for Qualcomm stock here

LTE share gains for Qualcomm in the near term

When China Mobile initially gave out a tender for 160,000 TD-LTE terminals last year, Qualcomm won a majority of the contracts due to its deep expertise in building multi-mode chipsets. In order to even the scales and allow local players to compete, China Mobile relaxed its handset requirements at the end of 2013 to include three-mode handsets as well. This allowed domestic chipset manufacturers to benefit from the sales of three-mode chips while they ramped up the design of their five-mode ones. However, it doesn’t seem as if these designs are ready to be shipped out yet. According to Marbridge, five-mode chips from local players are expected to enter mass production in Q2, and the first handsets with the chips are likely to appear only in Q3 this year. If the rumors about China Mobile reinstating its five-mode requirements are true, it gives Qualcomm an excellent opportunity to gain LTE chipset market share at the expense of local rivals in the near term.

However, we expect Qualcomm to increasingly feel the impact of LTE commoditization in the longer run as the eventual entry of local Chinese players increases competition, especially at the low end. On the other hand, Qualcomm’s lead at the high end is relatively safe given the maturity of its LTE solutions and the power efficiency of its integrated app processors. In Q3 2013, Qualcomm leveraged its high-end dominance well to claim a revenue share of 95% in the LTE baseband market – declining only slightly from 97% in Q1 2013. [3] Qualcomm’s grip on the high-end market should help offset some of the near-term impact of low-end ASP pressure in emerging markets. But as the LTE chips of local rivals such as MediaTek and Spreadtrum, as well as those of overseas rivals such as Nvidia, Broadcom and Intel, gain traction, we expect Qualcomm’s chipset ASP declines to accelerate in the coming years.

Five-mode to bolster Qualcomm’s royalties

A longer-term advantage for Qualcomm from China Mobile’s policy reversal is in its licensing business. Irrespective of who sells the chipsets, Qualcomm should benefit from the higher royalties associated with five-mode as compared to three-mode. This is because five-mode handsets have support for WCDMA and FDD-LTE, which increases the amount of royalties that handset makers will have to pay Qualcomm. Qualcomm’s royalty rate for LTE-only is about 125 basis points lower than for 3G. ((Tech Rumor of the Day: Qualcomm, The Street, June 2009)) Since Qualcomm doesn’t have a strong presence in TD-SCDMA and its royalty rates for LTE are lower than 3G WCDMA, China Mobile’s continued acceptance of 3-mode would have meant handset makers paying lower licensing fees to Qualcomm, at closer to LTE-only rates.

While five-mode increases Qualcomm’s chances at collecting more royalties from Chinese manufacturers, its upside potential could be limited by an anti-monopoly probe it is facing in China. The National Development and Reform Commission (NDRC) has said that it is looking into complaints that the company is charging a higher royalty rate in China than in other countries. If this is found to be the case, Qualcomm could face fines of anywhere between 1 and 10% of its annual revenues in the country. While the company earns almost half its revenues from China (over $12 billion in FY 2013), a bulk of those come from licensing patents and selling chipsets to foreign players such as Apple that have their supply chain in the country. It is therefore unlikely that such a large portion of Qualcomm’s revenues are at risk of incurring a fine. However, the regulatory moves do put a lot of Qualcomm’s future revenue growth in harm’s way, given that China and its local players are likely to be the biggest drivers of its licensing revenues in the coming years (see Qualcomm’s Regulatory Troubles In China Cast A Shadow Over 4G Opportunity).

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Notes:
  1. China Mobile to Reinstate 5-mode Requirement for 4G Chips, Marbridge, March7th, 2014 []
  2. China Mobile Requires 4G Smartphones to Support TDD/FDD, Brightwire, March 11th, 2014 []
  3. LTE Dominance Raises Qualcomm’s Baseband Share to Two Thirds in Q3 2013, Strategy Analytics, December 20, 2013 []
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  • commented 7 months ago
  • tags: BRCM QCOM CHL NVDA
  • Would you say similar declining predictions were made for Intel as it led the market?