Is Apple (AAPL) Replacing Qualcomm (QCOM)?

Investors in Qualcomm (NASDAQ: QCOM) have been a little nervous over past 24-hours following reports from DigiTimes that suggest Apple was creating an R&D team to create its own baseband processor. Currently, Apple uses Qualcomm
basebands and likely accounts for 15-18% of Qualcomm sales, according to Nomura Securities analyst Romit Shah.

While it seems feasible that Apple might want to integrate further at the baseband level, baseband development is difficult, Shah says. To date, only Qualcomm has a viable LTE solution on the market.

"If Apple is going down this route, it seems to carry a lot of execution risk and might suggest that the company is running out of other customization options. We suspect that Apple may be looking at one (or more) of three options when it comes to baseband development.

• Data only in-house solution Much of the complexity in the baseband layer is with regard to voice and multi-mode operation. A data-only solution, especially if LTE only, could prove a much simpler development. Nvidia has demonstrated the potential of this already, despite having a limited baseband capability. This solution would likely only find application in iPads and MacBooks, where it could reduce the cost of cellular connectivity and boost adoption rates of cellular enabled devices. The risks to Qualcomm from this development may prove limited, given that the iPhone is unlikely to adopt such a solution.
• Hybrid– license Qualcomm IP to create custom chipset - This scenario is also consistent with our checks that indicate that Apple has been developing some proprietary radio optimizations to reduce power consumption. We think Apple could use these customizations to further differentiate its devices from Android. In this scenario, we see Apple essentially licensing the baseband IP from Qualcomm and adding its own optimizations to it. As such, we don’t see any meaningful impact on Qualcomm's earnings (expect likely lower revenue to be offset by higher margin).
• 100% in-house integrated baseband and apps / graphics processor - This would likely provide the most scope for differentiation while also raising the risk of product delays / development failures. That said, we do not believe this to be a likely scenario as baseband development has proven to be a capital intensive and more importantly a risky undertaking. In addition, checks don’t suggest that Apple has developed or acquired the legacy baseband IPs that would be needed for backward compatibility to develop such a solution

"We rank this in the order we consider most likely – Data only in-house solution, Hybrid – license Qualcomm IP to create custom chipset and 100% in-house integrated baseband and apps / graphics processor."

The firm maintained a Buy rating and price target of $85 on Qualcomm. Meanwhile, they maintained a Neutral rating and $545 price target on Apple.

For an analyst ratings summary and ratings history on Qualcomm click here. For more ratings news on Qualcomm click here.

Shares of Qualcomm closed at $78.07 yesterday.

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