Investment Highlights

• Broadcom exiting Apple’s supply chain. The news of Apple planning to drop Broadcom as its supplier of WiFi/Bluetooth components (in 2025) and radio frequency (RF) chips (no definitive timeline) raise questions on the near-to-medium term earnings sustainability of the chipmaker and its suppliers. To determine the likelihood of the event, we look at past events that could provide hints on Apple’s motivation of having its own custom components and the hurdles facing the smartphone maker.

• Apple’s aspiration to own and have control over its primary technologies behind its products – dubbed as the Cook Doctrine – is public knowledge and the company has held true to this affirmation over the past decade. In line with this vision, the company has made several vital strategic decisions such as the transition to custom A-series and M-series chip, as well as plans to develop its own modem chip.

• Benefits of in-house design chips. Owning these technologies give Apple the flexibility and ability to further optimise its devices beyond what generic components could provide. Custom chip design, for instance, allows device makers to tailormake semiconductors by stripping unnecessary peripherals and use the extra space to optimise the primary application of the device. Besides that, custom silicon also allows Apple to add new features to its products that its competitors may not be able to replicate. Meanwhile, reducing dependency on third-party chipmakers also means the iPhone maker will have more influence on its chip supply chain and cost structure.

• Lessons from Qualcomm vs Apple. Facing the similar fate as Broadcom, Qualcomm is also speculated to be dropped by Apple as the smartphone maker plans to introduce its in-house modem chip. This is after Apple acquired Intel’s smartphone modem business in 2019 but the timeline has been a moving target ever since. Previously, Qualcomm was expected to provide only 20% of iPhones’ 5G modems in 2023F but due to the development of Apple’s in-house chip falling short, Qualcomm will continue to be the sole supplier with a new timeline being set by end-2024 or 2025 as reported by the news. Apple’s inability to penetrate the chip sub-segment despite the multi-year effort signifies that there is a high barrier to entry due to sheer technology know-how.

• What does this mean to Broadcom? Similar to the modem chip, the RF chip design will require Apple to have access to many patents and intellectual property to be competitive. Without heavy investment, it could be an uphill task for Apple to catch up with Broadcom’s technology, not without risking producing subpar components with potential issues or run into patent infringement. Even if Apple managed to break through the technology barrier, the device maker is likely to roll out the components for less complicated devices before working its way up, giving Broadcom more time to diversify its wireless business away from Apple.

• Could be a hard-bargaining tactic. We are also not ruling out the possibility of this could be one of Apple’s tactics to negotiate for lower prices given that Broadcom-Apple 2019 and 2020 supplier agreements are scheduled to end in mid-2023. In summary, we believe the risk of Broadcom losing Apple’s business is low in the near-to-medium term and the potential downside is limited. While the smartphone maker has the aspiration to design key components of its devices in-house, the high barrier to entry due to the need for heavy investments while offering minimal economic benefit may slow down, if not stop, Apple from further pursuing this direction, in our view.

• Maintain NEUTRAL. We believe semiconductors’ near-term earnings growth potential could be further capped by the potential slowdown of economic activities and sustained global inflation which are affecting demand for end-products, especially within the consumer-driven markets. Strengthening MYR against the US$ also may cause further earnings vulnerability. Our only Buy recommendation is Inari Amertron given its RF earnings and margin resiliency coupled with a strong balance sheet.

Source: AmInvest Research - 31 Jan 2023