The company designs chips that control the functions of smartphones and other gadgets, and is the dominant force at the low end of the smartphone market, where its products power phones costing from $60 to $700.

Late last month, Mediatek, which has a market value of around $10.5 billion, offered to buy local rival MStar Semiconductor (3697.TW) in a deal valuing MStar at about $3.8 billion, to give it a foothold in the market for chips for another upcoming device - the smart TV.

But before the TV business takes off, Chief Financial Officer David Ku told Reuters in an interview that what he calls "inexpensive high-end" smartphone products will be the key to growth.

"What are traditionally considered high-end products are moving aggressively to the low-price segment, but their product quality and performance are still very good," he said.

"This is why the volume of smartphones in this segment has risen so much. You don't see this volume growth in global brands, such as HTC (2498.TW)," he said.

China is emerging as a big market for cheap smartphones. Although Apple Inc's (AAPL.O) iPhone and Samsung Electronics' (005930.KS) Galaxy carry most cachet in the country's wealthy coastal cities, cheaper phones are finding markets in lower-income second- and third-tier cities.

The percentage of phones costing 1,000 yuan ($160) or less versus total smartphone shipments in China grew to 21 percent in the first quarter from 12 percent a year earlier, according to IDC figures.

China's Lenovo (0992.HK) is one maker of such phones to use Mediatek's designs. Ku said Mediatek has recently launched dual-core platform for cheap phones and plans to introduce faster, graphics-friendly quad-core as well as 4G LTE chips next year.

"Before, phones under $200 would not have possessed dual-core, but looking at the phones with our processors, you'll see a large number of $200 phones with dual-core in the market very soon," he said.

Mediatek, which outsources production of its chips to foundries like Taiwan's TSMC (2330.TW), sees its full-year shipments of smartphone chips at 75 million, up sharply from 10 million last year.

Sales of smartphone chips accounted for 15-20 percent of total sales in the second quarter, up from 10-15 percent in the first quarter.

Ku said the contribution from smartphone chips will by the end of this year surpass that of feature phone chips, which accounted for 38 percent of total revenue in the first quarter. Feature phones have fewer functions than smartphones.

Stiff competition will, however, keep margins under pressure in the second half, Ku said. Rival chip designers Qualcomm Inc (QCOM.O), Broadcom Corp (BRCM.O) and China's Spreadtrum Communications Inc (SPRD.O) are all active in or pushing into the low-cost phone sector.

The sector will become more important when $50 smartphones appear by the year-end, according to research firm Gartner's wireless research director Mark Hung.

"For smartphone adoption to grow fast in emerging markets it will require $50 phones," Hung said at a briefing in Taipei on Tuesday.

"Mediatek is very competitive because it combines R&D and a low-price business model," he added, noting Mediatek recently bundled multiple designs onto one chip to enhance value.

Mediatek will announce its full second-quarter results later this month. On Friday, it posted a 19 percent rise in revenue in the second quarter from the previous quarter.

Its buyout of MStar was the latest example of consolidation across the various sectors of the chip industry as the cost to make chips rises but the prices of the products they power falls, and Ku sees more consolidation to come.

"Funding has increased a lot because of the advance of technology. Ten years ago, only T$20-30 million ($668,000-$1 million) was needed to start a small fabless chip company, now it takes around T$20 million just to build a 28-nanometre mask," Ku said, referring to the plates used to etch chip circuit patterns on wafers.

For Mediatek, the MStar buy puts it into the smart TV business, which Ku said will be one of the main growth drivers in the future. However, a significant revenue contribution will take time because of a slower TV replacement cycle. The company will continue to work closely with Google (GOOG.O) on smart TVs.

Shares of Mediatek fell 3.6 percent on Tuesday, joining the rest of Taiwan's chip sector .TSII in declines after U.S. chip firm AMD (AMD.N) warned of a poor second quarter. The broader market .TWII fell 0.8 percent.

($1 = 6.3644 Chinese yuan)

($1 = 29.9570 Taiwan dollars)

(Editing by Jonathan Standing and Ian Geoghegan)

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