This Emerging Markets Mobile Play Became a Bargain

By Harsh Chauhan - August 13, 2012 | Tickers: CMGE, RDA, SPRD | 0 Comments

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Spreadtrum Communications (NASDAQ: SPRD), the China-based semiconductor company that makes mobile chips, was blown to smithereens after its second quarter earnings report was accompanied by a glum outlook. Although Spreadtrum’s results in the just-concluded quarter were ahead of what analysts’ expected, it seems that the market didn’t take much note of that.

But, would it be a good idea to ignore a company that’s riding the mobile revolution in emerging markets? Certainly not. With the stock having taken a solid beating due to a downbeat guidance, which was perpetrated by a supply chain hiccup and a shift in demand to low-cost phones, I would rather look at the drop with opportunistic eyes.

A brief review

Spreadtrum didn’t do too badly in the second quarter. The company’s revenue grew 8% from last year to $173.1 million as strength in demand for its smartphone products continued. Spreadtrum occupies a leading position in TD-SCDMA chips and the same showed in its top line performance in the quarter. It shipped above 1 million units of its 1GHz TD-SCDMA and EDGE chips and the trend would continue in all probability since Spreadtrum had recorded more than 200 design wins for the chip.

But the costs played spoilsport. Falling prices of its 2G/2.5G and 3G bundle semiconductors, which decreased 20%-24% from last year, hurt Spreadtrum’s gross margin. However, the company states that its margins have bottomed out as shipments of smartphone products have increased and we won’t probably witness another gross margin decline in the ongoing quarter.

Growing with the leader

Going forward, Spreadtrum looks set for a good time. The company has been a long-time supplier to China Mobile (NYSE: CHL), which is the leading wireless provider in the world. Through this relationship with China Mobile, Spreadtrum commands a lion’s share of the TD-SCDMA market in China. The company is set to ship above 10 million smartphone chips in the current quarter and its prospects are also boosted by the efforts China Mobile is making to speed up sales of TD-SCDMA handsets.

Moreover, Spreadtrum’s top line would also find a driver in the form of China Mobile’s handset replacement market. The wireless giant’s handset replacement market is nearing 100 million units every year, and Spreadtrum would find enough leg room to push out its TD-SCDMA enabled handsets. Also, Spreadtrum’s chips are being used by smartphone titans Samsung and HTC, notably the TD-SCDMA version of the Samsung Galaxy S III from China Mobile. Hence, being a supplier to the premium service provider and the leading smartphone companies on earth is an advantage one shouldn’t ignore.

Beyond the outlook

One of the reasons for Spreadtrum’s tepid outlook is change in consumer preference. Customers are moving from 3G-enabled feature phones to low-cost smartphones, hurting the company’s prospects in the short-term. Also, you might think that slowing growth in the Middle Kingdom might also be another deal breaker. But, as long-term investors, we need to look beyond just one economic cycle and examine the huge opportunity that lies ahead of Spreadtrum in the world’s most populous nation.

Also, the company is seeing a gradual ramp up in sales of high-end smartphones which carry a higher margin than the low-end ones. Hence, Spreadtrum’s pain would probably be short-lived and it can again get back into the good books of analysts and investors alike.

Dialing India

We also shouldn’t forget Spreadtrum’s penetration into the huge feature phone market in India through Micromax Informatics Limited. Micromax has built a base in the country where the demand for low-cost smartphones is really, really high. And since Spreadtrum has a contract with Micromax by way of which it is the favored chip supplier for its handsets, giving the company more space to flex its muscles in emerging markets.

Zig and Zag

Spreadtrum has been on a wild ride this year, a fact which is clearly evident if you take a look at its year-to-date chart. The company’s shares had crashed earlier in the year when analysts at Chardan Capital Markets said that Spreadtrum’s competitor, RDA Microelectronics (NASDAQ: RDA), was a better buy as it was chipping away at its market share.

However, Spreadtrum bounced back handsomely within a month with stellar first quarter results and an even better guidance. And looking back, Spreadtrum has gained an impressive 27% since it released its first quarter results even after its recent decimation while RDA has gone down 20% since then. Also, Spreadtrum’s dividend yield of 2% is another point of attraction for investors while RDA offers none.

The takeaway

Spreadtrum has a vast playing field of emerging markets ahead of it. Its chips are featured in leading handsets as well as feature phones and low-cost models in China and now in India. As a result, the huge drop in its stock price after the recent earnings announcement might well be an opportunity for investors to take a look at this mobile play from the emerging markets. 

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