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The surge in demand for Qualcomm Inc.’s (QCOM - Analyst Report) popular 28 nanometer Snapdragon S4 processors has induced the company to expand its supplier base by adding another chip manufacturer, United Microelectronics Corp. (UMC - Snapshot Report) to produce Snapdragon S4 processors.

United Microelectronics is expected to manufacture approximately 3,000-5,000 wafers a month, thereby meeting 20% to 30% of chipset requirements of Qualcomm.

Last month, Qualcomm teamed up with the world’s leading chip manufacturer, Taiwan Semiconductor Manufacturing Company (TSMC) in order to accelerate the supply of chipsets. However, TSMC failed to properly estimate the demand for chips in 2012, thus resulting in lower production of processors. So to mitigate the shortage of chips, Qualcomm not only joined hands with UMC but also selected Samsung Electronics to further boost its S4 processor supply.

The popularity of Snapdragon S4 dual-core processors is always on the rise as they are mainly used in high-end smartphones and tablets. They also support LTE technology, better graphics, high network speed and increased battery life, which make them more popular among top smartphone manufacturers.

As per Qualcomm management, more than 370 smartphones/tablets are slated to release in the upcoming months and will be using Qualcomm’s Snapdragon processors, out of which more than 150 will be using dual-core S4 chips.

According to Gartner research firm, tablet device sales are expected to increase by nearly 98% to 119 million units by the end of fiscal 2012. So keeping in mind the surge in demand for Snapdragon S4 processors, Qualcomm is continuously looking for different option in order to protect sales.

Apart from increasing their supplier base, they are also planning to temporarily substitute the S4 processors with the Fusion 2 chips, which is less complicated to manufacture compared to S4 processors. Moreover, the company may set up new plants to develop chips or may acquire any chip making company as it has a huge cash balance of nearly $26.5 billion mostly invested in marketable securities.

On the downside, we believe that increasing supplier base will expand its operating expenses in the near term. Moreover, we believe that stiff competition from NVIDIA Corporation’s (NVDA - Analyst Report) Tegra 3 quad-core processors may put additional pressure on Qualcomm’s market share in 2012 as they might lose certain wireless equipment manufacturers due to shortage of chipsets.

We maintain our long-term Neutral recommendation for Qualcomm. Currently, it has a Zacks #3 Rank, implying a short-term Hold rating on the stock.

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