TI's Rivals Take Aim

They're eyeing a piece of the lucrative cell-phone processor pie.
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Chipmakers, like Hollywood producers, love successful franchises.

And

Texas Instruments'

(TXN) - Get Report

Omap chip sports the distinctive hallmarks of a hit: It sells for a premium compared with other chips found in cell phones and is in a fast-growing market that TI has almost all to itself.

As TI prepares to release the third installment in the Omap story, the franchise is facing its toughest competition. A slew of chipmakers are revving up so-called application processors of their own in hopes of getting a place in the picture.

Broadcom

(BRCM)

announced its own application processor in November, and graphics-chip maker

Nvidia

(NVDA) - Get Report

promises to have one by year's end, thanks to its acquisition of PortalPlayer.

Meanwhile,

Marvell Technology

(MRVL) - Get Report

has emerged as one of the biggest players in the nascent market.

The imitation may be a flattering validation of a market that TI pioneered, but it also threatens the prospects of one of TI's most promising new businesses, as the company's stock has trended lower for the past 10 months.

"The wireless market has always been a very competitive market," says Alain Mutricy, vice president of TI's cellular systems group. Mutricy spearheaded TI's efforts to develop an application processor earlier in the decade, with the resulting Omap chip notching up 100 million unit shipments since its 2002 introduction.

The rise of application processors comes as cell phones evolve into powerful gadgets that serve as everything from digital cameras to personal music players. While the cell phone's traditional baseband processor handles the voice functions, an application processor takes care of everything else.

Like the microprocessor inside a PC, an application processor runs advanced operating systems, such as Windows and Linux, and supports the handset's multimedia features, such as music, video games and the now-common built-in camera. Some of the newest application processors, including TI's forthcoming Omap 3, can even handle high-definition video.

"These are the most advanced semiconductors in cell phones today," says Cody Acree, a semiconductor analyst with Stifel Nicolaus.

They're also among the most lucrative. Application processors typically sell for between $15 and $20 a pop, compared with the $10 price tag that's typical of a baseband chip. By selling an application processor, Acree says, a chipmaker can double the revenue it earns from every cell phone.

And unlike baseband processors, which require approval by communications regulatory agencies to be sold in many countries, application processors are not constrained by red tape, says Will Strauss, principal analyst of market research firm Forward Concepts.

This means that a chip firm can parlay its circuit design skills into the cell-phone market, without the headaches and delays that accompany baseband chips.

"The barriers to entry are much lower

than in baseband chips, and it's a faster-growing market, so that makes it very attractive to a lot of people," says Strauss.

With more than a billion cell-phone handsets shipping a year, the potential market for application processors is huge.

According to Strauss, unit shipments of application processors grew 54% in 2006 to 100 million units, and there are now at least a dozen companies making application processors.

TI had a dominant 69% share of the application processor market in 2005, according to Forward Concepts. The 2006 numbers, which the firm will release in a few weeks, will see that share significantly reduced, although TI will remain the No. 1 player in the market, Strauss says.

Marvell, which purchased

Intel's

(INTC) - Get Report

Xscale application processor business

for $600 million in June 2006, finished the year a formidable No. 2 player in the market, displacing

Qualcomm

(QCOM) - Get Report

, says Strauss.

The increasing competition will likely drive down the rich price of application processors -- a possibility that TI's Mutricy says the company is prepared for. "We continuously have to be cost-competitive," he acknowledges.

TI does not break out revenue or profit margin figures for its Omap business, although analysts believe the gross margin is higher than TI's overall level of roughly 50%.

TI's advanced chip manufacturing and its deep understanding of handset customers will hold the Omap business in good stead even in a more crowded field, contends Mutricy.

TI is the first company to announce an application processor built with 65-nanometer circuits -- the most advanced generation of semiconductor technology -- with its forthcoming Omap 3, although analysts expect Qualcomm and others to announce 65-nanometer application processors in the coming months.

"To be successful with application processors, it's really important to play at the leading edge and then to also have the modem

baseband capability," says Mutricy.

That's because over time, many of the application processor's features are integrated into the baseband chip. While TI makes both baseband and application processors, some of the new application processor hopefuls, like Nvidia, lack the baseband side of the equation.

As a result, say analysts, those companies could be relegated to providing stand-alone application processors to a smaller, high-end segment of the market.

"If integration happens, they've got nothing to integrate it with," explains Citigroup chip analyst Glen Yeung. Citigroup owns 1% or more of Texas Instruments shares and has provided Texas Instruments and Nvidia with noninvestment banking services in the past 12 months.

As nicely as TI squares up against the competition, the greatest challenge to Omap lies beyond its control.

For application processors to become a standard cell-phone component, demand for mobile multimedia content needs to take off among mainstream consumers.

Apple's

(AAPL) - Get Report

forthcoming iPhone, which combines a cell phone and the popular iPod MP3 player, is expected to act as a catalyst. But a missing piece of the puzzle is the rollout of high-speed 3G, or third-generation, wireless networks and services -- something that has been slow to get off the ground outside of Japan.

Until 3G catches on, TI and the rest of the application processor gang could be fighting for a mere slice of a much larger pie.