Yahoo Finance Qualcomm Faces a Renewed Threat From MediaTek
One of the biggest winners of the mobile revolution has arguably been Qualcomm (NASDAQ: QCOM). Qualcomm designs many of the important chips that power today's smartphones, including the applications processor (the main brain of a smartphone), wireless connectivity chips, and even auxiliary components like fingerprint scanners and 3D sensing modules.
The company is the leading vendor of mobile applications processors, capturing 42% revenue share during the first half of 2017, according to Strategy Analytics.
Image source: Qualcomm.
While the market for mobile applications processors was once crowded, with many players trying to capitalize on this large market, many vendors simply dropped off the radar as they couldn't achieve the necessary scale to justify the endeavor. The company that emerged as Qualcomm's main competitor was Taiwan-based MediaTek.
Qualcomm has historically had a product and technology advantage over MediaTek, which allowed the former to dominate the market for high-end mobile applications processors while bringing stiff competition in the midrange and low-end of the market -- a market where MediaTek primarily plays.
According to DIGITIMES, which cites statements made by MediaTek executives, MediaTek is set to boost its spending on research and development in a bid to improve its competitive positioning in the mobile system-on-a-chip (SoC) market. Let's go over what this could mean for both MediaTek and Qualcomm.
Increased spending could yield better results
To a real degree, there's a positive correlation between the amount of money that a company spends on research and development and its product competitiveness. A larger research and development budget can allow a company to work on a broader range of products -- expanding its served addressable market -- and to make the products that it does build better.
A bigger research and development budget means that a company can afford to pay talent more, which helps companies bring in more capable people to work on products. Moreover, a larger budget can mean that a company can throw more engineering resources at particular projects, which can allow companies to build products with more aggressive feature sets, better efficiency, and higher performance.
It's generally a good sign when a chip company spends more because the potential competitiveness of the products it builds improves. That can lead to higher market share, better gross profit margins (since better products can typically sell for more), or a combination of both. It's a good thing for stockholders.
The risk, though, is that if a company spends that additional research and development money and it doesn't lead to meaningfully more competitive products, it'll have increased its cost structure without a corresponding improvement in revenue and gross profit, ultimately reducing profitability.
According to MediaTek chairman MK Tsai (via DIGITIMES), MediaTek thinks that the fruits of this increased spending will begin to manifest itself in terms of increased market share and profitability "as early as end-2019."
The threat to Qualcomm
Should MediaTek's efforts to boost its product competitiveness and market share prove successful, it's a virtual certainty that this success will come at Qualcomm's expense. In recent quarters, Qualcomm's chip business has seen both revenue and profitability on the upswing. During the company's fiscal year 2017, it reported a 7% year-over-year increase in revenue and a 52% increase in earnings before taxes in its chip business.
MediaTek, by contrast, reported a 13.5% decrease in its net revenue in 2017, with operating income sinking 57.4%. It's likely that Qualcomm's success last year came at MediaTek's expense.
The bad news for Qualcomm is that if MediaTek can deliver on its promises to improve its competitiveness, then investors could see a reversal in the dynamics that have been playing out recently. On the bright side, though, Qualcomm has demonstrated that, even from a position of leadership, it was able to extend that lead.
Although I have expressed my displeasure with some of Qualcomm's big-picture strategic moves -- e.g., entering the data center processor market, going after the Windows PC processor business -- the company's product and technology execution in its core mobile processor business has been strong and only getting stronger in recent years.
I think that, while MediaTek is certainly making the right moves to try to improve its competitive positioning, Qualcomm is almost certainly cognizant of the potential threat of renewed competition of MediaTek and is highly likely to adjust its own efforts to respond.
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Ashraf Eassa owns shares of Qualcomm. The Motley Fool owns shares of Qualcomm. The Motley Fool has a disclosure policy.
