Want to Profit From the Chinese Mobile Market? Take a Look at This Stock

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Shares of Spreadtrum Communications (NASDAQ: SPRD) crashed almost 9% after the company released mixed third-quarter results, and a dour outlook didn’t help either. I was expecting Spreadtrum to top estimates this quarter and provide further impetus to its stock price which has had an excellent run over the last six months. However, a spike in operating expenses hit the company hard, leading it to miss bottom line estimates.

Spreadtrum’s outlook was not great either. It expects revenue between $189 million and $196 million in the current quarter, while consensus estimates call for $194.7 million. If this wasn’t enough, Spreadtrum stated that it’s expecting its operating margin to stay at third-quarter levels in the ongoing quarter. These factors weighed heavily on investors’ minds as they went scurrying for cover after the report.

Into the Details

But what’s the big deal with this operating expense spike that cut down Spreadtrum’s operating margin to 13.4% in the quarter from 21.4% in the prior-year period? Well, the company is a major player in the market for Chinese smartphone components and it is expanding its product portfolio aggressively. A 26% jump in Spreadtrum’s research & development spending clearly reflects this fact, and this was the primary driver behind the decline in operating margin.

Spreadtrum is investing in new technologies for expanding its WCDMA, LTE and other connectivity offerings. The company aims to expand its presence into international markets and it is accordingly looking to improve its offerings.

I believe that Spreadtrum’s investments into new and innovative technology are much needed at the moment. The Chinese TD-SCDMA market is a very competitive one, and with the likes of Qualcomm (NASDAQ: QCOM) entering into the fray, it is set to get even more cutthroat. Qualcomm has already scored a big win in the form of the Lumia 920, Nokia’s latest flagship which is being offered by China Mobile (NYSE: CHL).

With its army of Snapdragons, Qualcomm is quite capable of eating into the high-margin, premium handset market and as such, Spreadtrum needs to put on its innovation cap. Hence, the pain of high operating expenses due to research & development shouldn’t be taken as an alarming sign as Spreadtrum is pulling the right strings.

Aiming Higher

Spreadtrum is already the supplier of choice for marquee smartphones such as the Samsung Galaxy S III and the HTC One X in China, but it is not resting on these two laurels. The company is already testing its dual-core system on a chip (SoC) and will test the quad-core platform next year. This will further improve its product portfolio.

Spreadtrum expects that these platforms, along with WCDMA, will help it move between 80 million and 100 million chipsets next year. This is a stupendous jump when compared to the 30 million chips it expects to ship this year. The company expanded its Samsung account by becoming the first Asia-based handset vendor to supply 2.5G baseband chips to Samsung. Samsung has already started shipping budget phones with these chips globally, opening a huge budget handset market for Spreadtrum.

Getting Better

In addition, the movement of consumers from budget phones to smartphones in China is another positive for the company. Smartphones carry a higher margin and Spreadtrum is witnessing an improvement in product mix as people move to smartphones. This fact has hit home as Spreadtrum turned in an improved gross margin this quarter, which improved 20 basis points sequentially and is expected to remain stable in the current quarter. Spreadtrum was suffering due to declining prices of 2.5G and 3G products, but now it seems that things are better on this front.   

The China Mobile Opportunity

Spreadtrum is already a leading company in the Chinese TD-SCDMA market and is poised to enjoy solid growth due to its partnership with China Mobile. A huge number of China Mobile’s customers are shifting from older 2.5G technology to TD-SCDMA driven handsets. As a result, the total addressable market for TD-SCDMA chips will grow from 85 million units currently to 140 million units next year.

Hence, China Mobile’s handset replacement program will give a huge boost to Spreadtrum. Moreover, China Mobile is doing its bit in propelling sales of budget smartphones by distributing them through open market channels and this will enhance Spreadtrum’s prospects further.

The Bottom Line

Spreadtrum’s profit might have taken a hit, but the company is spending money to improve itself further. It aims to achieve double-digit annual revenue growth from 2013 and these investments are necessary if Spreadtrum has to achieve its target. Thus, it won’t be correct to write off Spreadtrum just because its expenses are rising and ignore the positive developments.

Spreadtrum is looking to tap the huge potential that the Chinese mobile market presents, and it also carries a decent dividend yield of 2%. Hence, a 9% drop in the stock price opens up a portal for potential investors to get in.

TechJunk13 has no positions in the stocks mentioned above. The Motley Fool owns shares of China Mobile and Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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