Bernstein Research‘s Stacy Rasgon reiterates an Outperform rating on shares of Qualcomm (QCOM), and an $85 price target, arguing that worries about competition in the China market from low-cost chip providers, as well as an ongoing investigation by the government into Qualcomm’s practices, should no be a big worry for the company or its shares.
Bears warn of a three-fold threat in the China market, a market that is, Rasgon observes, “potentially a source of significant upside” for Qualcomm.
First, Taiwan’s MediaTek (2454TW) and other lower-cost providers could derail Qualcomm’s sales, they contend:
MediaTek has demonstrated their ability to gain share in the China market even when they were behind Qualcomm in 3G technology. Currently, MediaTek is poised to have three integrated LTE SoCs in 2H14 at multiple price tiers, with a product roadmap closely following Qualcomm’s, including 64 bit offerings (quad-core MT6732 and octa-core MT6752). Investors fear that Qualcomm’s ability to capitalize on the LTE transition in China will be hindered by the further presence of competition in the region.
But Rasgon argues Qualcomm maintains a commanding lead in meeting the necessary complexity of the semiconductors required, especially for newer LTE-based smartphones:
Most competitors for the China market are well behind Qualcomm on integration, geometry, and radio technology, and Qualcomm holds the majority of sockets currently certified for use on China Mobile’s forthcoming LTE network. Of the primary competitive candidates, MediaTek is likely the most viable (and fierce) competitor, and understands well how to do business in China. However, Qualcomm’s challenges on 3G have been, in our opinion, more on marketing to the Chinese consumer than anything else. And, it appears Qualcomm is now getting much more responsive to the demands of Chinese market. Despite previously deriding octa-core chips as a marketing gimmick, Qualcomm is fully embracing the multi-core trends, announcing its own octa-core chip, the Snapdragon 615 (or MSM8939) at the MWC. The chip clearly is aimed to counter MediaTek’s success in the octa-core segment, and is targeted at the mid range. Similarly, in another marketing effort Qualcomm is targeting their first 64 bit chip (the Snapdragon 410 MSM8916) designed specifically for the needs of the lower-end China market, delivering high performance into lower end segments at attractive price points.
Bears warn China could bring down Qualcomm’s average selling price:
China Mobile expects to have ~200 TD-LTE models this year, with ~100M unit deployments, including some priced around RMB 1,000. Many handset makers have expressed the strong intention to have TD-LTE phones to support China Mobile’s deployment pace (Exhibit 7). Many investors fear the rollout of these devices, on top of perceived continued price erosion in the traditional 3G smartphone market, will result in significant erosion of device ASPs and a severe decline in licensing revenues.
Such fears are nothing new, he writes:
Fears of ASP decline have been part and parcel with Qualcomm ever since the “Great ASP Debacle” of 2010. However, mix to emerging markets is not new; QCOM’s QTL unit growth has been driven by this shift for years (Exhibit 8). ASPs have increased markedly since that time, even as emerging market growth has substantially outpaced unit growth in developed markets, more than offsetting negative mix as the smartphone cycle continued apace.
Lastly, China’s regulators could impose harsh requirements on Qualcomm, the bears argue:
The recent regulatory issues in China, particularly the anti-monopoly case, have caused some angst among investors (though we note the stock itself appears to have weathered it so far). Nevertheless, given the relative lack of transparency there is a fear out there that China is getting ready to hit Qualcomm over the head with a sledgehammer. The recent Lenovo-Motorola deal has added some fuel to the fire as well, with some investors worried that this gives a large Chinese company access to a patent base that will weaken Qualcomm’s position. The most bearish out there hold to a view that these are just the tips of the iceberg, eventually leading to an eventual collapse of the patent franchise that Qualcomm has patiently built over the years (and which of course drives the majority of the value of the company).
Rasgon argues Qualcomm can pick up a lot of new royalty payments from a “shadow” economy of smartphones subject to its intellectual property, and that the company is doing more to “engage” with authorities in the country:
As the 4G market, over the next few years, potentially transitions here we would love to see QCOM put a framework in place to capture payments; even if at a lower rate we believe they would still be substantially accretive as this large “shadow volume” of 3G moves over into royalty-bearing mode. We estimate substantial accretive contribution from China Mobile LTE to Qualcomm’s royalties as a result, even if it comes at a lower rate. The push toward 5-mode chipsets may help with this […] Additionally, it appears that Qualcomm is upping their engagement with China. We note recent news that Qualcomm is engaging with SMIC for 28nm products. While Qualcomm has indicated they will be upping their foundry multi-sourcing efforts, we were somewhat surprised to see SMIC mentioned at least in the guise of 28nm, and SMICs inferior capabilities vs. TSMC or Samsung all suggest limited benefits to QCOM from a strict multi-sourcing perspective (benefits on pricing, flex capacity, etc). Benefits to Qualcomm from assuaging China, however, could in theory be much more substantial, and the timing of the newsflow (in the middle of the investigation) suggests other motives may indeed be at play.
Qualcomm shares today are down 44 cents, or 0.6%, at $77.01.
