Spreadtrum Communications, Inc (ADR) (SPRD): Is This China-Focused Smartphone Chip Maker Still a Bargain?

Spreadtrum Communications, Inc (ADR) (NASDAQ:SPRD)Prior to releasing its first-quarter’s results, the Asia-focused baseband communication chips manufacturer Spreadtrum Communications, Inc (ADR) (NASDAQ:SPRD) significantly increased its guidance for the second quarter. The company cited strong growth in low-cost smartphones in the emerging markets, particularly China. As a result, its shares rose by 21% in after-hours trading.

Spreadtrum now expects revenue for the current quarter will increase by 42.9% to 47.1% from the second quarter of 2012 to a range of $270 million to $278 million. Previously, Spreadtrum Communications, Inc (ADR) (NASDAQ:SPRD) was expecting revenue of between $220 million and $228 million.

Spreadtrum’s rally has also caused a rise in shares of other wireless-chip manufacturer and sellers with exposure to emerging markets, such as Skyworks Solutions Inc (NASDAQ:SWKS) and the largest seller of mobile-phone chips QUALCOMM, Inc. (NASDAQ:QCOM) .

Skyworks supplies power amplifiers and front-end modules to original equipment manufacturers (OEMs), including some of the leading smartphone and tablet companies such as Samsung, Apple Inc. (NASDAQ:AAPL), HTC and Sony Corporation (ADR) (NYSE:SNE). Despite a solid business model, in the last 12 months, Skyworks Solutions Inc (NASDAQ:SWKS)’ shares have fallen by more than 14% while its competitors have risen by 17%.

Recent reports highlighting weakness in demand for Samsung and Apple Inc. (NASDAQ:AAPL) smartphones have hurt the company’s shares badly. However, I believe that the company’s fundamentals are strong and its future is very much bright. Its amplifiers and modules are present in almost every other smartphone around the world. In its recent earnings release, Skyworks Solutions Inc (NASDAQ:SWKS)beat both top- and bottom-line estimates. For the current quarter, the company’s revenue guidance came in below estimates but it remains strong on the earnings front.

Spreadtrum and TD-SCDMA

Spreadtrum Communications, Inc (ADR) (NASDAQ:SPRD) is the leading supplier of TD-SCDMA and earns most of its revenue from Korea and China. The TD-SCDMA is the 3G standard which is used by China Mobile Ltd. (ADR) (NYSE:CHL) the biggest telecom operator of the world and the market leader in China. Sreadtrum is a primary supplier to local Chinese firms. Some other analysts have identified that Spreadtrum could be supplying to two of the biggest names in Chinese smartphone market: Huawei and ZTE.

Spreadtrum Communications, Inc (ADR) (NASDAQ:SPRD) supplies mainly to the low-end of the Chinese market. I believe that this is its competitive advantage which has given it a strong foothold in the world’s biggest smartphone market. However, there is a catch here; serving this particular segment translates into lower margins.

The gross profit margins of Spreadtrum and QUALCOMM, Inc. (NASDAQ:QCOM) are presented in the picture below. As is evident, Qualcomm earns nearly twice as much margin than Spreadtrum Communications, Inc (ADR) (NASDAQ:SPRD). The former supplies primarily to companies that cater the high-end of the market such as Samsung, HTC, and Nokia Corporation (ADR) (NYSE:NOK).

According to the research firm IDC, the shipments to China of TD-SCDMA phones in the first quarter of 2013 reached 28 million units, showing a massive increase of 390% from the same quarter last year. Of this, four out of every five phones cost less than $200 – the low-end phones.

Spreadtrum has recently launched its dual-core 1.2GHz smartphone chipset for TD-SCDMA and EDGE. DigiTimes has highlighted the company’s dominance in TD-SCDMA. Last year, it captured almost 50% share of the TD-SCDMA market. This year, its shipments could grow by as much 300%. But will this translate into an increase in market share? Probably not. In fact, DigiTimes goes as far as to suggest a 10 percentage point drop in market share. The reason: competition.

This portion of the market, which is a high-volume low-margin operation and includes firms such as Spreadtrum Communications, Inc (ADR) (NASDAQ:SPRD), MediaTek and Allwinner Tech, has been growing quickly while growth at the higher-end has been slowing down. As a result, it has attracted attention of the bigger players, such as QUALCOMM, Inc. (NASDAQ:QCOM).