Broadcom Finally Ditches Cellular

Shares of Broadcom (NASDAQ: BRCM  ) closed up nearly 10% today after the company announced that it will be bowing out of the cellular baseband space. The company's hope was that it could emerge as a viable second source to market leader Qualcomm (NASDAQ: QCOM  ) in the baseband/applications processor market, although this has proved to be quite a challenge for the company. After what was likely billions burned chasing cellular, Broadcom's management has finally pulled the plug on this expensive venture. 

A rather large cost savings
According to Broadcom's press release, the company expects to save as much as $700 million in GAAP R&D and SG&A expenses (of which $100 million consisted of share-based compensation expense). While a large investment in its own right, it still doesn't hold a candle to the over $3 billion that market leader Qualcomm invests per year, making catching up to the leader very difficult.

Further, the company claims that the entire cellular business during the first half of 2014 was on track to generate between $200 million and $250 million, with gross margin in the tens of millions. This suggests that even though Broadcom will lose meaningful revenue associated with this business, the impact to raw gross margin dollars won't actually be that high (probably because most of the current revenue base consists of low-margin 3G chips). Most of that $700 million saved will flow right to the bottom line (and potentially into the pockets of shareholders via buybacks and dividends), with $50 million peeled off to bolster investments in the company's other businesses.

Does this leave connectivity vulnerable?
One of the key motivations behind Broadcom's cellular push was to defend its share in connectivity chips that provide key functionality such as Wi-Fi, Bluetooth, and NFC. At the high end of the market (think Samsung (NASDAQOTH: SSNLF  ) and Apple (NASDAQ: AAPL  ) ), Broadcom has been able to defend its share by providing better-performing parts that also topped the charts on energy efficiency. At the low end and mid-range, however, many handset OEMs prefer to get the entire platform from one company rather than incur additional R&D expenses mixing and matching components from different vendors.

This business, according to Broadcom, is worth between $500 million and $800 million of the company's total $1.65 billion-or-so mobile and wireless operating segment. The risk to this business is real, particularly as Qualcomm, MediaTek, Intel, and others already (or plan to) offer such bundled solutions for these lower-end mobile products. However, Broadcom claims that its connectivity solutions are bundled as part of some low-cost smartphone chip players' platforms (for instance, Spreadtrum), so not all is lost in this segment of the market.

Foolish bottom line
While the smartphone chip market has gained a reputation for being low-cost and low-margin, this has largely been due to the accessibility of CPU/GPU IP and a glut of companies thinking that they could cash in on this new mobile goldmine. However, as the complexity of these products have gotten much higher, and as cellular basebands have proved expensive to compete in, the reality is that even with the accessibility of core IP, R&D barriers will eventually lock all but a select few out of this market.

Broadcom is just yet another of the victims of the chase of mobile chip riches, but it certainly won't be the last. Only those that can afford to spend large amounts of money over sustained periods of time will be able to compete with market leader Qualcomm. The next question, then, is "who's next?"

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