Description

Investment thesis

Qorvo’s stock is dragged down by short-term semiconductor supply-chain problems, creating an opportunity to own a high-quality chip maker for a long-term oriented investor. Qorvo’s end markets will likely see robust growth in the next few years because of the 5G spending cycle. The stock has a 50% upside in a rerate once the supply chain situation normalizes in the next 12-18 months and the company should enjoy a healthy growth prospect in the next 3-5 years.

Business 

There are mainly two types of chips: digital and analog. While digital chips, like CPUs, handle complex calculations with binary inputs, analog chips encode non-digital real-world signals to digital and vice versa. Analog chips are especially important for mobile devices because many real-world signals are measured in frequencies not in a digital format. If we say CPUs are the brains of electronic systems, then analog chips are the eyes and ears. Without analog chips, the CPU will not be able to receive real-world inputs to process. 

Qorvo, an analog chip maker,  breaks down its business into two segments: Mobile Products ("MP") and Infrastructure and Defense Products ("IDP"). MP is a global supplier of cellular, Ultra Wideband 802.15.4z ("UWB") and Wi-Fi solutions for a variety of applications, including smartphones, wearables, laptops, tablets and Internet of Things ("IoT"). The main customers in this segment are smartphone manufacturers: Apple, Oppo,Vivo,Xiaomi, Samsung, and etc.  IDP is a global supplier of radio frequency ("RF"), system-on-a-chip ("SoC") and power management solutions for applications in wireless infrastructure(cell towers), defense, Wi-Fi, smart home, automotive and IoT. The IDP segment serves a more diverse portfolio of products with generally longer life cycles to a broader base of customers.

Customer Concentration

Qorvo, along with Skyworks(SWKS), are the two main providers of RF chips to mobile phone manufacturers and their business currently are heavily indexed to the mobile phone market. Apple is Qorvo’s biggest customer accounting for 30% of its total revenue in FY 2021. Android phone makers such as Oppo and Xiaomi in China also account for a significant portion of Qorvo’s revenue, around 30% by my estimate. Huawei accounts for less than 5%. The split between Qorvo’s MP and IDP businesses is about 70:30. 

Long-term Structural Tailwind

Dollar content increase for analog chips in the smartphone: With the development of 5G, the mobile computing revolution is entering a new phase. Although the smartphone market has become relatively saturated, much more powerful and sophisticated RF(radio frequency) chips are needed in order to meet the performance mandated by the 5G standards. Dollar content per 5G smartphone will increase significantly over 4G. As management commented on the latest call, mid and low range android phones currently have about $10-13 RF content. There's a $5-7 RF content increase per 5G phone compared to a 4G phone, a 50% revenue increase opportunity per device. As Apple has already equipped their latest models with 5G chips, android phones will need to move the majority of their product lines to support 5G in order to stay competitive . 

Analog chips for IoT: We have already witnessed a proliferation of emerging computing devices and the number of smart/connected devices is only going to increase exponentially from here. As long as there's a need for wireless processing, there's a need for analog chips to process these wireless signals. IoT is a new opportunity that will rapidly expand once the current supply-chain crunch eases. One market that was breaking out is the semiconductor for vehicles as indicated by a dramatic increase in chip content in EVs versus traditional ICE vehicles that caused a well publicized shortage this year. Wearables, smart factories, smart cities, smart appliances, and smart homes will all need wireless components with RF chips to communicate. Emerging computing platforms such as the VR/AR helmets are also ditching the cords and going wireless. 

Technology rivalry spurs 5G infrastructure spending: To support all the 5G data transmission we need to build out new 5G backbone infrastructure. It’s clear to every major country that whoever wins the 5G race will realize enormous benefits. China had the head start in this but now everyone else is ramping up. The current 5G race is great for the global telecom infra industry that Qorvo participates in. COVID delayed 5G deployment worldwide but as the world returns to normal it’s certain that 5G spending will ramp up. Based on past telecom development cycles of 3G and 4G, there’s usually a 3-5 years of spending ramp up before the plateau and we are in the very early innings of the 5G upgrade cycle. 

Competition:

Mobile phone markets: Qorvo competes mainly with Skyworks on front-end RF modules in high-end phones such as the iPhone or Samsung’s flagship Android phones. On mid-tier android phones, Qorvo competes with NXP,Qualcomm, and Broadcom. 

IDP: Qorvo competes primarily with Analog Devices, Inc.; Cree, Inc.; MACOM Technology Solutions Inc.; NXP Semiconductors N.V.; Silicon Laboratories Inc.; Skyworks Solutions, Inc.; STMicroelectronics N.V.; and Sumitomo Electric Device Innovations.

I view the competition dynamics here as intense but stable. All companies listed here are established semiconductor players that spend a lot of resources to stay at the edge of technology. As management said during the recent call, it is easy to calculate market share by using the number of chips shipped to and the total shipment of each smartphone manufacturer. Based on Qorvo’s calculation, management stated that they are not losing share to any supplier.

Why does this opportunity exist

Although growing a healthy 16% YOY on the topline in the latest quarter, Qorvo was still impacted by supply chain challenges. The stock was sold off after the company announced the Q3 earnings results and weak Q4 outlook which incorporated a sizable revenue hit caused by supply-chain issues. While Qorvo is a vertically integrated chip maker and can make enough products itself, its customers reduced orders because other parts are unavailable. Apple is the biggest customer in the entire semiconductor supply chain so every supplier sells to Apple first. Android phone makers take Apple’s leftovers. Other customers such as car makers and game console makers probably get even lower priority. That’s why in today’s environment we see Apple is still relatively fully supplied yet the carmakers are starving for chips and PS5/Xbox is nowhere to be found. When exactly the supply will normalize is anyone’s guess. However, we have seen a lot of capital spending to boost semiconductor production so this shortage will very likely lessen in 2022 or 2023. 

Valuation

Using the current consensus estimates, for its fiscal year ending in March 2022, Qorvo will grow revenue about 18% with 52% gross margin and 28% net income margin. FY2023 estimates put Qorvo’s forward PE at a little more than 12X. But FY2023 estimates only assume a 7.6% growth, which could be low if the supply-chain issue improves. In a normalized environment, I think the broader non-smartphone IoT market could easily grow 15-20% and the smartphone market could grow HSD for Qorvo because of the aforementioned chip content dollar growth per Android device from upgrading to 5G. 

Upside

Based on the healthy growth trajectory in the next 3-5 years for various 5G end markets, a 18X FY2023(ending in March 2023) forward P/E is reasonable for QVRO, implying about 50% upside from its current stock price. 

Why QRVO but not SWKS

Qorvo’s stock is just a bit cheaper and the company has a little more diversified customer base than SWKS. Apple is the largest customer to both QRVO and SWKS but SWKS has 60% revenue from Apple vs QRVO’s 30%. As Apple has already upgraded the majority of its phones with 5G RF chips, QRVO should enjoy a bigger revenue boost in the future when Android phone makers upgrade to 5G. 

Catalyst

Supply chain normalizes to meet pent-up demand in electronic devices

5G infrastructure spending growth

RF dollar content increase in android phone