Spreadtrum Communications: A mobile chip off the old block
What’s not to like about a company that makes parts for one of the fastest-growing consumer products in one of the world’s fastest growing markets?
Spreadtrum Communications Inc. (Nasdaq: SPRD), a Shanghai company that makes chips for the mobile handset market, is in that enviable position today, amid a surge in demand for both basic low-priced and fancy high-end cell phones.
Last month, IDC reported that worldwide handset shipments in the third quarter of 2007 totaled 289.1 million units, up 9% from the previous quarter and up 13.8% from the year-earlier quarter.
While that robust growth is good news for a long list of mobile chip makers that includes U.S.-based Texas Instruments Incorporated (NYSE: TXN), it is exceptionally good news for Spreadtrum, whose home base of China is not only the world’s largest cell phone market, but, thanks to its low-cost labor, is also the source of more and more of the world’s cell phone production.
Not only does Spreadtrum have the geographic advantage of being close to so many of the companies that buy its chips and the consumers who buy the phones that contain them, but the small cap also pays a lot less for labor than its U.S.-based rivals, meaning it can more easily translate revenues into net income.
When it reported third-quarter results in October, Spectrum showed that all those advantages added up to a very fast growth rate. The company said third-quarter revenues surged 44% to $38.6 million, while net income rose to $6.1 million or $0.13 per share, compared with $3.7 million or $0.11 in the year-ago quarter.
Judging from the growth shown in its core telecom chip product, it appears Spreadtrum’s overall growth could accelerate going forward. The company said that its telecom chip revenues surged 59% in the third quarter, a rise that was offset by a decline in its turnkey solutions division, a business that bundles wireless chips with other cell phone components. Spreadtrum is currently in the process of phasing out that lower-margin, turnkey business.
Spreadtrum’s value proposition is easy to grasp and when the company went public earlier this year, there was significant pent-up investor demand. The shares, which were set to start trading somewhere between $11 and $13, opened at $14 and closed that day at $15.95. They have since rallied as high as $17 before settling back to a current level of about $14.45.
Most of the analysts who cover Spreadtrum—such as Jay Srivatsa of Roth Capital, who initiated coverage with a “buy” recommendation in October—are optimistic. Six analysts who track earnings are forecasting earnings per share will total $0.43 in fiscal 2007 and rise to $0.79 in fiscal 2008. Seven analysts who provide revenue guidance are looking for total revenues to reach $143.6 million in 2007 and rise to $210.2 million in 2008.
During a recent conference call, Spreadtrum executives noted that the company’s headquarters in China were becoming more of an advantage as a flurry of new media features—such as video ring backs—shortened replacement cycles among customers eager to access the latest features.
In China, where carriers do not lock consumers into long-term contracts, the average cell phone replacement time is between 11 and 18 months, which is shorter than the time that it takes some western companies to upgrade their chips. Spreadtrum’s manufacturing process is focused on maintaining a rapid time to market so that its chips do not become obsolete. Moreover, its chips are designed to tightly integrate hardware and software so that handset manufactures can easily add customized features.
All this talk of Spreadtrum’s advantageous location and its swift manufacturing process should not diminish the simple fact that it is very good at what it does. Spreadtrum has a longstanding track record of leadership in the development of advanced chips with more multimedia features.
In 2003, it developed the world’s first chip supporting the emerging GSM (global system for mobile communication) and GPRS (general packet radio service) wireless standards. More recently, it has been developing chips aimed at improving the music sound on cell phones to CD quality.
Still, Susquehanna Financial Group analyst Adele Mao stresses that China’s handset market today is dominated by second generation, or 2G, technologies. Although she said she is impressed by Spreadtrum’s performance to date, she notes that it has still not demonstrated it can dominate the 3G market. Mao currently has a “neutral” rating on Spreadtrum’s shares.
“We would become incrementally more positive should new product introductions point to better-than-expected market share gains,” she wrote.
Mao raises a fair point. But investors who wait to see how the 3G mobile landscape develops in China may wait too long to buy Spreadtrum (SPRD). Judging by the company’s track record, it stands an excellent chance of continuing to grow its market share. Following a recent sell off of its shares, now may be an excellent time to invest in this stock.
