Qualcomm’s Revenue Growth Slows Amid Smartphone Saturation, Slow LTE Sales in China
Qualcomm (NASDAQ:QCOM) announced a mixed set of Q2 FY2014 results on April 23rd, as revenues rose only 4% year-over year, but net earnings came in ahead of guidance on healthy expense optimization across verticals. Although in line with guidance, revenue growth declined sharply from historical rates of over 20% that shareholders have grown accustomed to in recent quarters. This is a direct impact of the smartphone market in developed markets reaching its peak, causing handset makers to shift their focus to cost-sensitive emerging markets such as China, and left Qualcomm vulnerable to near-term fluctuations in smartphone demand in the country. Last quarter, 3G CDMA device sales in China suffered ahead of an anticipated LTE ramp-up at China Mobile, which caused retailers to aggressively burn through TD-SCDMA inventory in preparation for the transition. As a result, Qualcomm’s licensing revenues took a hit, growing by less than 1% over the same period last year.
Chipset sales fared much better, growing year-over-year by 8.4% as Qualcomm leveraged its LTE lead over rivals to improve the mix of its premium-tier chipsets. The ongoing cost management initiatives helped the company post strong chipset margins, which came in ahead of expectations at 17.4%. The company expects the second half of the year to be substantially better than the first half, as LTE sales ramp up in China and its cost-cutting efforts show their full impact. The strong performance on the margins front saw Qualcomm increase its fiscal-year EPS guidance by 1% at the mid-point, but over-reliance on a back half recovery increases uncertainty around the company’s annual guidance.
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Going forward, higher shipments of LTE smartphones as China transitions to the new 4G standard are likely to provide some near-term support to device ASP levels, but we expect that to be more than offset by a broader decline in smartphone prices due to intensifying competition at the low end (see Assessing Competitive Risks To Qualcomm As A Nascent LTE Market Matures). We also expect Qualcomm to suffer market share declines, especially at the low-end, to local players such as MediaTek in emerging markets. We have slightly revised our price estimate for Qualcomm to $75, almost in line with the current market price.
Smartphone saturation shifts focus to emerging markets
Qualcomm’s increased focus on cost optimization comes as its revenue growth tapers off amid growing saturation in the high-end smartphone market. Carriers in developed markets such as Verizon and AT&T are looking to control subsidies and boost margins, and handset makers are increasingly searching for growth in international markets. Apple’s recent quarterly results show as much, as iPhone sales were driven largely by growing penetration in emerging markets such as the BRIC nations.
As a result, Qualcomm’s future revenue growth will be increasingly driven by emerging markets such as China and India. These countries have very low 3G/4G penetration, and carriers there are intent on driving data usage through smartphones. According to IDC, smartphone sales in China increased by 67% over the previous year to reach 350 million in 2013, giving the country a share of about 35% of the world market. That figure is expected to increase by another 30% to 450 million this year. [1] Most of the growth is likely to be driven by local players such as Lenovo, Coolpad, Huawei and Xiaomi.
LTE Transition At Chine Mobile
The biggest opportunity for Qualcomm in China comes from China Mobile, which is transitioning from the TD-SCDMA standard to TD-LTE. China Mobile is not only China’s largest wireless carrier, but also the world’s, with a subscriber base of over 760 million that overshadows Verizon’s by almost seven times. Its market share of Chinese wireless subscribers stands at about 65% currently. Qualcomm faced some headwinds in the region last quarter, as customers deferred buying decisions in anticipation of China Mobile’s LTE foray and retailers aggressively moved TD-SCDMA inventory to make way for TD-LTE handsets. Given Qualcomm’s limited licensing presence in TD-SCDMA, this did not translate into royalty income. On the other hand, it ate into CDMA volumes at other carriers, which would have otherwise contributed to Qualcomm’s licensing top line. Qualcomm estimated the CDMA volume hit at 17 million units last quarter.
Going forward, however, the TD-LTE transition at China Mobile will be a big positive for Qualcomm since the semiconductor giant has found it easier to sign on licensing partners for TD-LTE. With China Mobile looking to offset its 3G disadvantage with LTE, a big portion of a hitherto inaccessible subscriber base opens up for Qualcomm to collect handset royalties on. Qualcomm will also be looking to leverage its overwhelming LTE lead over rivals to corner a greater portion of chipset sales in China. China Mobile’s recent decision to sell only five-mode handsets is a big positive for Qualcomm in the near term, as its multi-mode 3G/LTE chipsets are significantly more mature than those of rivals. This should make it easier for the company to land high-end design wins.
However, any advantage that Qualcomm will have over rivals will only be in the near term, with five-mode chips from local players expected to enter mass production in Q2 and the first handsets with these chips likely to appear in Q3 this year. So far, Qualcomm has managed to leverage its first-movers’ advantage to claim a lion’s share (95% in Q3 2013) of the LTE baseband market. Going forward, we expect Qualcomm to increasingly feel the impact of LTE commoditization as the eventual entry of local Chinese players such as MediaTek and Spreadtrum, as well as overseas rivals such as Nvidia, Broadcom and Intel, increases competition, especially at the low end (see Qualcomm To See Near-Term LTE Market Share Gains in China But Regulatory Uncertainties Remain).
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- China’s Smartphone Shipments to Exceed 450 Million by 2014, IDC, September, 2013 [↩]