Gleacher & Co. expects mobile chip maker Qualcomm (NASDAQ:QCOM) to be a primary beneficiary in the 3G/4G growth and will remain the top supplier for integrated chips and extend its leadership position to LTE.
We expect 3G/4G connected devices such as smartphones and tablets to become a greater part of the consumer discretionary budget and drive multiple years of double-digit growth in QCOM's royalty business, analyst Stephen Patel wrote in a note to clients.
QCOM's total available market (TAM) will likely expand to over 70 percent of handsets in the next 4 years, up from about 40 percent last year, driving above-market growth and warranting a premium multiple, in our view. In chips, Patel see opportunity for content gains as handsets require more processing power, Patel said.
The brokerage expects that as smartphone mix grows from about 20 percent in calendar 2010 to over 35 percent in calendar year 2013 and as China (860 million subscribers) and India (790 million subscribers) adopt 3G, QCOM will grow its royalty base by over 50 percent in the next 3 years.
In addition, cellular connectivity in devices such as tablets, e-readers and notebooks opens up additional growth avenues.
We estimate the royalty base from these new devices to grow by 5x in the next 3 years to 16% of the mix, factoring in only minimal contribution from notebooks, the analyst said.
On the, application processors area, the analyst sees a mixed bag. Qualcomm's Snapdragon chip has made inroads at HTC, LG and Sony, but he sees low odds that Qualcomm will win meaningful application processor content at Samsung, Motorola or Apple.
Meanwhile, Sony-Ericsson was the first handset vendor to announce it would be impacted by the Japan quake in March. In recent days, it has indicated that the launch of the Xperia Neo has been delayed from the spring to the fall and that the Xperia Arc and Play would launch in more limited volumes than originally expected. All three Android handsets use Snapdragon.
While any unit impact to Sony could be offset by share gains from other vendors such as HTC, we see it as a modest negative that a Snapdragon customer has been impacted, Patel said.
However, royalties drive about one-third of Qualcomm's revenue and two-thirds of profits. Royalty operating margins are typically in the low- to mid-80 percent range.
Based on investments by Intel (NASDAQ:INTC) in cellular as well as Qualcomm's embedded cellular (Gobi) initiatives, the analyst said he would not be surprised if cellular penetration in notebooks eventually surpassed 50 percent in a 3-5 year period.
If penetration hit 20 percent in calendar year 2013, this would represent about 50 million notebook units added to the royalty base. At a $500 average selling price, this would potentially expand the royalty base by $25 billion or 13 percent.
While this would be subject to a cap if embedded, we think the contribution would still be very substantial. Alternatively, if sold into the notebook in module form, contribution to the royalty base would be far lower, but an estimated floor around $6/unit would still provide a significant contribution, the analyst said.
Patel has a buy rating and a $64 price target on Qualcomm stock, which closed Friday's regular trading session at $53.14 on Nasdaq.