Is The Slowing Smartphone Demand In China A Concern For Broadcom?

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China is one of the most important markets for Broadcom (NASDAQ:BRCM), with the company deriving approximately 55% of its revenue from the region. The recent slowdown in China’s growth and the devaluation of its currency by the People’s Bank of China sent the global stock markets in turmoil last month, though some of the losses have been reversed in the last few weeks. A slowdown in the Chinese economy could have a big impact on chipmakers, as growing demand from the region is one of the primary factors that has driven strong growth for most of these companies in the last few years. Goldman Sachs recently listed Broadcom as one of the top 5 companies with significant exposure to China, and urged investors to be cautious while investing in companies which derive a considerable proportion of their revenue from the region.

Broadcom is one of the many companies that have benefited from the smartphone surge in China in the last decade or so. However, the economic slowdown has impacted smartphone sales in the region. Is Broadcom’s connectivity business at risk from the slowdown in smartphone sales in China?

While the slowing smartphone growth in China could impact Broadcom’s short-term growth, we believe that the company’s long-term growth trend remains intact. There is still growth potential in the Chinese smartphone market. Additionally, the burgeoning Internet-of-Things (IoT) market in China could provide a bigger boost to Broadcom’s connectivity business.

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Our price estimate of $46 for Broadcom is at an approximate 10% premium to the current market price. The company is in the process of being acquired by Avago Technologies. The combined entity will create a global diversified leader in wired and wireless communication semiconductors, and become the 3rd largest U.S. semiconductor maker by revenue. (Read: Broadcom To Be Acquired By Avago In Record Tech Deal)

See Our Complete Analysis for Broadcom Here

Despite Slowing Growth, China Remains The Largest Smartphone Market

China has seen an exponential increase in its smartphone market in the last decade, driven by its expanding middle and upper class, rising disposable income, an increasing Internet user base, and rising 3G/4G penetration. It is currently home to the world’s largest smartphone consumption and production base in the world. However, China’s smartphone shipments declined for the first time in 6 years in Q1 2015, as the market continues to mature. Market demand in the region is now driven more by replacements than first time buyers.

Despite the slowing growth, China is still the largest smartphone market and accounts for almost 30% of the global smartphone sales. According to research firm IDC, most of the market’s growth will come from sub-$150 phones as feature phone users switch to low-cost smartphones. According to Statista, the percentage of China’s population using a smartphone will increase from 38.5% in 2014 to and estimated 51.6% in 2018. Given that the country has the largest population in the world, the projected growth is still significantly higher compared to the developed countries. Market Research Store predicts that the number of smartphone shipments and users in China will rise to 768 million and 964 million by 2019, respectively, up from 450 million and 610 million (respectively) in 2014.

Though Broadcom exited the smartphone baseband market last year (on account of intense competition and shrinking profits), it is the leader in connectivity solutions. Apple (NASDAQ:AAPL) and Samsung (PINK:SSNLF), two of the largest smartphone players in the world, are its key customers and together account for approximately 28% of Broadcom’s net revenue. For years, Broadcom has been developing technology designed to reduce the cost of entry for smartphone consumers in emerging markets, and thus is in a strong position to leverage the growing low-cost smartphone userbase in China. The company also has a considerable lead in providing connectivity solutions to the mid- and high-tier segments.

China Will Be One Of The Biggest IoT Markets

In addition to the smartphone and tablet markets, new and existing markets have increased in prominence as drivers of Broadcom’s new growth potential in emerging markets.  These include IoT, automotive electronics, wearable devices and small cell technology. The expansion in the above mentioned segments (especially IoT), which are still at a nascent stage, will further increase the need and demand for Broadcom’s connectivity portfolio.

IoT is implemented by connecting various devices with each other as well as with communication devices of end-users. Wireless communication, Broadcom’s forte, is one of the key technologies used to implement IoT. China is home to a fast -growing community of developers and technology entrepreneurs. Also, being the most populous country, it is expected to be a big consumer of IoT devices.

TechNavio’s analysts forecast the IoT market in China to grow at a CAGR of 32.15% between 2014-2019, with Broadcom being one of the prominent vendors. [1] By 2020, China’s IoT market is expected to hit $166 billion. ((IoT in China: Towards a Connected Future, Broadcom Blog, May 23, 2014))

Broadcom’s Low Cost Platform To Help Increase Its Presence In IoT

In order to tap the IoT growth potential in emerging markets like China, Broadcom is strengthening and diversifying its portfolio with new low power connectivity solutions for IoT.  It has also boosted support for Apple’s iBeacon and HomeKit commercial and home-based connectivity standards. Last year, Broadcom launched its WICED platform, a low-cost, low-power development tool that provides out-of-the box connectivity to help get new IoT products to market faster.

The company claims that while increasing smartphone use may have triggered the inception of the IoT market in China, its continuing emergence is being driven by Wi-Fi and Bluetooth Smart, a low-energy flavor of Bluetooth that’s ideal for small devices that run on long-lasting batteries, such as wearables. ((IoT in China: Towards a Connected Future, Broadcom Blog, May 23, 2014))

A focus on developing software and very-low-power-consumption chips targeted at IoT products for emerging markets will help Broadcom expand its footprint in the market. Just as with smartphones, China will play a key role in the expansion and development of IoT, given its size and role in the global economy.

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Notes:
  1. Internet-of-Things (IoT) Market in China 2015-2019, PR Newswire, March 26, 2015 []