After learning their lessons as university students in or around California's Silicon Valley, co-founders of chip design firm Vimicro International (VIMC) are now reaping rewards in China's Silicon Valley.

Those co-founders are natives of China. They figured Vimicro would have better luck in their homeland for two reasons. One was low-cost manufacturing. Another was government help on taxes and research and development.

"(Operating in China) would be important for long-term growth," said Chief Executive John Deng.

His team's plan was to design and sell analog, digital and mixed signal processing chips. Vimicro would hire engineering graduates from China's universities and outsource production to Chinese fabrication plants.

After its launch in 1999, Vimicro set up shop in a Beijing tech zone near notable Chinese tech firms Sina, (SINA) Baidu.com (BIDU) and Lenovo, which acquired IBM's PC business in May.

Vimicro has since become one of China's biggest homegrown chip companies. It's also the country's first fabless chip design house to trade in the U.S.The company went public on the Nasdaq in November.

Its success in one end market in particular — image processors for the PC camera market — has made it the global market leader.

"They basically went from zero percent global market share to 60% global share in four years," said analyst Tore Svanberg of Piper Jaffray, which has provided investment banking services to Vimicro.

Vimicro's revenue from PC cameras — which generate most of its sales — is driven by the growing use of voice and video communication over the Internet.

It's the only chip supplier that offers both video and audio capabilities on a single integrated chip, analyst Quinn Bolton of Needham & Co. wrote in a report.

Vimicro didn't start making much money until last year. That was partly due to heavy R&D and infrastructure spending.

The company's 2005 revenue hit $95 million, up from $50 million the prior year. Analysts polled by First Call expect it to earn 60 cents a share this year and 75 cents a share in 2007.

Vimicro's advanced chip designs for PC cameras are used by customers like Logitech (LOGI) and Creative Technology, (CREAF) two dominant vendors in that market.

The company also sells to Lenovo. And it's worked with Microsoft (MSFT) on developing Web cameras for video chatting on MSN.com, Deng says.

Room To Grow

More than 1.9 million video conversations take place daily on MSN 7.0, Bolton notes. The service was launched last April and boasts about 10 million unique users.

While cameras are embedded in about 20% of the desktop market, just a small portion of notebooks come with them, Svanberg says. That presents further opportunity for Vimicro.

Sony already has rolled out high-end notebooks using Vimicro's silicon.

Bolton estimates that as much as 20% of the worldwide notebook market will come with integrated cameras by the end of 2007. Some 86 million notebooks are expected to ship in 2007.

Meantime, Bolton expects most large PC equipment makers to bundle Web cams with their products over the next few years.

Market Mobility

With success in the PC camera market, Vimicro is leveraging its name and know-how in the mobile handset market, which it entered in late 2004. The company's chips are now in more than 200 different handset models.

The mobile phone multimedia chip market could grow 20% to 30% a year the next few years, according to industry figures. It's a larger and more competitive market than PC cameras, analysts say.

Vimicro's partnerships with Chinese carriers such as China Unicom (CHU) and China Telecom (CHA) might help it win new multimedia cell phone business at home.

"The Chinese government encourages technology companies to use local vendors," Svanberg said.

Top global handset companies said to be vying for business in China — including Nokia, (NOK) Samsung, LG Electronics and Motorola (MOT) — have not tapped Vimicro, however.

Vimicro's handset clients do include two of the largest wireless operators doing business in China: Bird and PCL. It also sells to Japanese and Korean handset firms.