QCOM disruptive solution in the RF arena

A recent question here asked how does QRVO’s competitive position compare to SWKS? As an investor in Qorvo, Inc. (QRVO) and Qualcomm Inc. (QCOM), I contend that this question is simply too narrow in focus and needs to be broaden for a macro assessment, i.e. , “How do ALL the major players - QRVO, SWKS, AVGO and QCOM - stack up against each other in the highly competitive RF landscape?”

All four companies are major component providers in the OEM supply chains of smartphones and other mobile devices. Here are two examples shown in the tear-down of the Apple iPhone 6 and 6 Plus
http://www.techinsights.com/teardown.com/apple-iphone-6/
and the Samsung Galaxy S6.
http://www.zdnet.com/article/samsung-galaxy-s6-teardown/
https://www.ifixit.com/Teardown/Samsung+Galaxy+S6+Edge+Teard…

Samsung chooses to keep most of its supply chain in-house from development to final assembly and outsource low-cost commoditized components that are more easily replaceable to subcontractors.

Apple, on the other hand, outsources most of its manufacturing to suppliers that are tightly controlled by Apple’s procurement team. Unlike Samsung, Apple does not offer nearly as many device variants, allowing them to focus on the supply of fewer components overall. In addition, Apple devices have the highest loyalty rates in the industry, giving Apple unprecedented bargaining power with its manufacturing subcontractors.

A significant comment in one of the Apple iPhone 6 teardown articles caught my attention [my emphasis in bold]:
Qualcomm makes their appearance in a few places, but not as a total RF solution. The baseband support for both Apple iPhone 6 devices is from Qualcomm’s Gobi Modem product line- the MDM9625M, with RF transceiver and RF receiver roles being supported by their WTR1625L and WFR1620 ICs respectively. The only other RF support we see from Qualcomm is with their power envelope tracking IC, the QFE1100. As for the other RF functions such as the RF antenna switches and power amplifiers, Apple once again uses multiple manufacturers like RFMD [now QRVO], Murata, Avago, and Skyworks. Based on our quick analysis, this is the same RF design strategy Apple used on the iPhone 5, iPhone 5S, and iPhone 5C.

In all my posts about RFMD and QRVO, I’ve always mentioned QCOM as a major threat. Back in February 2013, QCOM dropped a bombshell on players in the RF chip market, when it revealed its ambitious project that would address and solve the most difficult, most complex problem of cellular radio frequency band fragmentation by developing and delivering for the first time a single, global 4G LTE design for mobile devices. The “Qualcomm RF360 Front End Solution” would include an antenna tuner, envelope power tracker, integrated power amplifier (CMOS) and antenna switch (ASM) and full packaging solution. In a nutshell, this disruptive technology would solve the problem of 4G LTE and LTE-A band fragmentation where “multiple versions of the same LTE device are required to accommodate the worldwide proliferation of cellular bands (40 plus and counting); the problem gets even worse when you consider the different band combinations required to support LTE-Advanced carrier aggregation.” This is the total RF solution, highlighted above in the tear-down article comment, that techies are aware of and waiting for the first installation. QCOM’s initial target is the Chinese market; QCOM’s ambitions, of course, are much larger long term. Not surprisingly, after this announcement, the market over-reacted with a sell off by RFMD, TQNT and SWKS investors. Others saw this sell off as a buying opportunity for the short term because they knew that, historically, QCOM’s entry into new chip markets have had only modest success in the first 1-2 years, but almost universal success over a 3-5 year time frame, given its substantial Research & Development (R & D) scale and systems expertise and sometimes through acquisition. Here’s the Qualcomm RF360 Front End Solution website with details and video presentations.
https://www.qualcomm.com/products/gobi/rf360-front-end-solut…

Since then, RFMD and TQNT joined forces with a merger that created QRVO at the end of 2014. Since 4G LTE networks use many different spectrum frequencies that require more complex antenna and signal technology, SWKS developed and sold high-value, more advanced RF content in smartphones and tablets.

In order to compete and survive, QRVO, SWKS and AVGO must stay ahead of the technological curve by committing sufficient capital to fund their R & D. This, however, is where QCOM has a monster competitive edge and advantage over its smaller RF brethren, as clearly shown in the following table. In FY 2014, QCOM spent a record $5.4 billion for R & D.


         Mkt.Cap       R & D  Cash & Equiv.    LT Debt           
          5/8/15       FY 14         FY 14       FY 14      

QRVO    $ 11.3 B   $ 0.192 B(a)  $ 0.118 B         0
SWKS      18.6 B     0.252 B       0.805 B         0  
AVGO      31.6 B     0.695 B(b)    1.604 B     4.543 B
QCOM     113.1 B     5.477 B       7.907 B         0 

[Notes: (a) Since QRVO is a newly merged company, the R&D amount above covers only 9 months; (b) Since AVGO is a diversified company, corporate reports do not reveal how much of the FY 14 R & D spending is attributed to its wireless communications group that accounts for about 40% of total revenues.]

As expected, QCOM’s total RF solution has experienced modest success over the first two years. On 12/8/2014, QCOM gave the following status: “With all 1st generation products having launched and 2nd generation in the midst of commercialization, the RF360 front end solution has clearly come of age. And as the 225+ number (of design wins across 40+ OEMs) indicates, there is still a lot more waiting to happen in the future!” Now in its 3rd year of development, who knows when QCOM will be ready to make their entry pitch to smartphone OEMs. In the 2nd quarter 2015 earnings call, the QCOM President related: “ It’s worth noting that we are still in the very early days of LTE adoption. According to GSMA intelligence only 8% of global connections are LTE. In February, China granted nationwide FTD-LTE licenses to both China Telecom and China Unicom. Each of the Chinese operators has announced significant investments in LTE network build-outs and has set aggressive targets for subscriber additions this year.”

Here’s the latest take by Morningstar on 5/1/2015 that assesses SWKS in the highly competitive RF landscape that includes QCOM [my emphasis in bold]:
http://analysisreport.morningstar.com/stock/research?t=SWKS&…

we doubt Skyworks will ever gain a stranglehold on the entire smartphone RF market. Several competitors have similar product offerings, and traditionally, handset makers have split their business enough among these RF firms to prevent a single firm from dominating the market over time. Although Skyworks counts Apple as a key RF customer, for example, Apple also uses RF content from Qorvo in each phone. This buying power may someday lead to pricing pressure for Skyworks, as wireless firms seek to reduce the cost of their phones in a brutally competitive market.

We do not believe Skyworks Solutions has an economic moat. (snip) Although Skyworks’ supplier relationship with Apple appears secure, if not strengthening, over the next two years, if Skyworks were to ever completely miss out on an Apple design cycle and lose 100% of its business with Apple for an extended period of time, we estimate that Skyworks’ returns on capital from its remaining handset and nonhandset customers could potentially fall below the firm’s cost of capital. [my comment: this means that SWKS would no longer create any value] Skyworks’ returns could fall even further if losses at Apple were combined with losses at other smartphone customers, perhaps due to either a disruptive technology or increased competition from Qualcomm, which has focused on the RF space. While we think that a total loss of Apple’s business is only a remote possibility today, and perhaps even less likely than it was a couple of years ago thanks to design efforts to resolve complexities around 4G LTE technologies, such a loss would likely lead to major value destruction, which in turn inhibits us from assigning the firm a narrow economic moat.

Risk. We view Skyworks’ greatest risk as its highly concentrated customer base that consists of large handset makers like Apple and Samsung. These firms may be able to exert pricing pressure on Skyworks and limit its ability to generate exceptional returns, in our opinion. Weak performance by any major customer will drag on the company’s earnings even further. Skyworks’ RF chip revenue from handsets should continue to hinge on key design wins–supplier relationships with Apple products have undoubtedly given the company an earnings boost in recent years, but the firm could suffer if Apple ever cut Skyworks out of the loop in future generations of these devices. Qualcomm’s entry into the RF chip space poses a large risk to RF chipmakers, in our view, if the company can leverage its market leadership position in mobile processors into the RF space as well. Finally, although Skyworks has done well to diversify a portion of its business into nonhandset opportunities, the firm squares off against a host of well-capitalized firms in the analog chip space with decades of design experience.

BOTTOM LINE:
In the near term without any deployment of the QCOM disruptive technology in the smartphone RF arena, I anticipate that all four companies will continue to compete for a piece of the action. The driving force in the competition will increasingly become who offers components at the lowest cost. In addition to the lucrative growth prospects as Apple, Samsung and other suppliers, all four companies will seek to capitalize on China’s excellent growth opportunities as the Chinese market begins to deploy higher-bandwidth cell service on the LTE standard. As device functionality and complexity increase, RF content in smartphones will realize a significant boost, and major players like Qorvo, Skyworks, Avago and Qualcomm will seek to position themselves well to reap the benefits of this trend.

From now and out two or more years , QCOM is absolutely committed and determined to expand its footprint and position in the supply chains of Apple, Samsung and other OEMs by completely dominating the RF arena with the eventual deployment of its disruptive total RF solution, provided, of course, it is cost competitive and efficient in size, operation, battery power consumption and other factors. When that day comes, it will deliver a devastating blow with major adverse impacts on QRVO, SWKS, AVGO and others in the RF arena.

For now, I am keeping my QCOM investment and, as always, holding QRVO with vigilance, watching for any major moves by QCOM with its disruptive technology.

As always conduct your own due diligence.

Regards,
Ray

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Hello Ray,

Many thanks for this post. I have been thinking for a couple of weeks about commenting on SWKS which is enthusiastically (and profitably) viewed in these parts. Your post allows me to focus on my main point rather than have to give a great deal of background.

I believe that the low PE the market has placed on SWKS is a combination of factors:

  1. The potential disruptive introduction of RF 360 by QCOM has made modeling of the RF sector in general and SWKS, in particular, more problematic. No one knows IF QCOM will attain dominance in RF, and, even if they suspect the answer is yes, do not know WHEN. Wall Street abhors uncertainty and there is an abundance here.

  2. The RF industry is rife with a history of capacity over-supply and under-supply. It last came out of over-supply in late 2011 and has enjoyed a great run of increasing returns the past few years. What could bring about the next over-supply?

  3. There is growth on the horizon and that is accepted by industry participants, both companies and their investors. There is a history,
    however, of forecasted growth turning into major disappointments.

The above, IMO, balances the optimism surrounding SWKS and results in a quarter by quarter re-assessment by investors. In other words, as long as performance is demonstrated, everything is fine. However, it can change quickly and price erosion can result. This board is populated by folks who are wise enough to not let any one holding grow to a point where portfolio risk becomes inappropriate.

Best regards,

Mike

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Ray,
Thanks for a great post. I appreciate it when a preponderance of facts tempers my enthusiasm. There is sufficient reason to cool my previous attitude about SWKS. I still think it’s a good investment, but there is more uncertainty about the future of the company than I had thought.

As with every investment, one must closely watch the company and the competition, review the stock price occasionally.

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