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Founded in 1985 in San Diego, California, Qualcomm (NASDAQ: QCOM ) is the world's leading chip designer for wireless technologies, including 3G and 4G/LTE. The company is also keen to be a leader in 5G.
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The designer's focus is noteworthy because, unlike traditional chipmakers like Intel (INTC) and Samsung (OTCPK: SSNLF ) (OTCPK: SSNNF ), Qualcomm doesn't yet have manufacturing facilities and its chips are made by contract manufacturers. Taiwan Semiconductor (TSM) licenses or licenses (the so-called “independent manufacturing model”) to manufacture and use its intellectual property in, for example, smartphones, tablets and smartwatches.
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As an indicator of technology leadership, companies that manufacture or use chips in their devices in the aforementioned mobile communications areas must obtain a patent license from Qualcomm. So it's no surprise that Qualcomm's customers include Apple (AAPL), Samsung, Huawei, LG, Oppo, Sony (SNE) and Xiaomi (OTCPK:XIACF) (OTCPK:XIACY) global technology leaders and smartphone makers. In its annual report, Qualcomm names more than 210 companies that use Qualcomm technologies in their products and pay Qualcomm royalties.
In addition, Qualcomm's Snapdragon LTE modem is considered the most powerful chip in the LTE market. To address Apple's reliance on Qualcomm in the production of the iPhone 7, replacing Qualcomm chips with Intel chips has caused performance issues in many iPhones. To avoid this performance issue in the LTE-enabled Apple Watch Series 3, Apple relied on Qualcomm's Snapdragon chips.
According to the Washington Post last week, Apple's hardware executives used phrases like “the best” to describe Qualcomm's engineering. Another Apple memo describes Qualcomm as having a “distinct set of patents.”
Qualcomm's business consists of three segments: QCT (Qualcomm CDMA Technologies), QTL (Qualcomm Technology Licensing) and QSI (Qualcomm Strategic Initiative). While QCT and QTL are profitable segments, QSI is a strategic investment and will not be considered in this context.
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Most of Qualcomm's revenue comes from selling mobile communications chips (QCTs). Most of the revenue is derived from the high-end enterprise that owns patent rights and licenses for 3G, 4G/LTE and 5G (QTL) technology. Depending on the source, QTL's revenue is around 3-7% of the wholesale price of a smartphone sold globally.
The QCT segment contributed 76% of revenue in fiscal 2018, while the QTL segment accounted for 54%, or more than half, of revenue before tax (EBT) (see table below).
Qualcomm has been accused in several pending lawsuits since 2014 of abusing its monopoly power to raise prices.
On the one hand, Qualcomm has suspended payments pending the conclusion of several lawsuits with Apple and its suppliers, as well as the Huawei lawsuit.
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Qualcomm, in turn, has been fined billions of dollars in various global court rulings.
All of these factors have caused Qualcomm's revenue and earnings to decline over the past five years, and its stock price has come under severe pressure due to fears of declining profits. However, a dividend of about five percent was paid to shareholders during this period.
On May 3, 2018, I last published an article titled “Why We're Trading Now” on Qualcomm in Search of Alpha, and presented two scenarios for short-term and long-term investors.
On the one hand, I discussed the long-term prospects of the acquisition of NXP (NXPI), which will create a leading chip company in the fields of mobile communications technology, the automotive industry, and digital payment solutions. .
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On the other hand, I talked about the upside potential of the share price in the context of the announcement of a public buyback program of 20-30 billion dollars, at which time it will be equal to 27-40% of the market capitalization. . At the same time, I discussed the rationale and absurdity of this share buyback program.
Although the acquisition of NXP was shelved due to delays in the Chinese regulatory approval process, the company announced a $30 billion share buyback plan on July 25, 2018 ($7.8 billion of which was completed on December 31, 2018). expected). .
This announcement of the share buyback program caused the stock to rise from $59 to $74 within a few days (representing a 25% increase in the stock price).
Amid a general correction in the stock market, uncertainty over a trade deal with China, and a legal dispute with Apple, the stock fell again to around $49 in late January 2019.
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Additionally, in my May 3, 2018 letter, I added that Qualcomm executives intend to settle their licensing dispute with Apple by the end of the year, preferably out of court. In this context, it has been reported that Qualcomm's licensing model has also been revised. The price threshold for calculating monthly fees has been reduced from the initial $500 to $400 per device (smartphone manufacturers must pay a percentage of the device's cost to Qualcomm).
In this regard, I added that the revision of the licensing model should help resolve existing licensing disputes with Apple and Huawei in a timely manner, as well as avoid licensing disputes and legal disputes with other Licensors. So, assuming the previously described points are well developed, Qualcomm's direction should start from Sleeping Beauty's sleep.
I guessed that the price hikes we've seen in the Broadcom takeover battle are a little peek into Qualcomm's true value.
On April 16, 2019, it was announced that Apple and Qualcomm had agreed to drop all lawsuits involving Apple's payment to Qualcomm. The companies also entered into a six-year license agreement effective April 1, 2019, including a two-year term and a multi-year chip supply agreement.
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As a result of this announcement, Qualcomm's stock price exploded again, rising nearly 45 percent in a few days (see chart below):
UBS analyst Timothy Arcuri estimates that Apple paid Qualcomm between $5 billion and $6 billion to settle the global lawsuit, although the exact amount of the payment was not disclosed.
Qualcomm said in a filing about the deal that it expects EPS to increase by about $2 as shipments increase. This expectation is in line with Qualcomm's 2019 guidance announced in April 2018. Finally, the resolution of the licensing dispute with Apple will positively impact non-GAAP EPS by between $1.50 and $2.25 (see figure below).
Meanwhile, Intel has announced that it will exit the 5G smartphone modem business following the Qualcomm-Apple settlement. Instead, Intel will focus on 4G and 5G modems for computers, the Internet of Things, and other data-centric devices. This should make it clear that the 5G modem for the iPhone (as well as for the iPad and Apple Watches) will be delivered by Qualcomm from 2020. In any case, Qualcomm is considered the leading designer of 5G modems, and the current modem in its 5G portfolio is called the Snapdragon X50.
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First, Stifel is going for Qualcomm's purchase price ($100 PT) and says management's $2/share earnings growth forecast suggests Qualcomm's license fee is little or no decline.
Second, Evercore moved from In-Line to Outperform and again rated Qualcomm's stock as an “investment grade” after the Apple deal. The firm raises the price from $60 to $90.
Although valuation based on cash flows is difficult today without additional guidance from management, EPS guidance for the financial year can be used to provide a realistic valuation against the peer group.
As noted earlier, Qualcomm's management expects earnings per share for fiscal 2019 to be between $4.47 and $5.22. While the licensing dispute with Huawei is still pending, I am cautious on the underlying valuation and expect GAAP EPS to be $5. With last week's closing price of $79.89 on Thursday, the P/E ratio for fiscal 2019 will be 16. Compared to non-GAAP EPS of $7.50, the P/E ratio is lower at 10.65.
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Looking at the peer group's valuation, it should be noted that despite Qualcomm's market leadership and semi-monopoly status in the 5G sector, licensing disputes with Apple and Huawei have led to a discount trade. For example, Texas Instruments ( TXN ) ( 22.04 ), Taiwan Semiconductor Manufacturing ( 22.13 ), and Xilinx ( XLNX ) ( 34.88 ) have P/E ratios at least 37.5% higher than Qualcomm's.
On the other hand, companies like Intel ( INTC ) (12.98) and Micron ( MU ) ( 6.82 ) have low P/E ratios. However, this is not surprising, as Micron produces very low-end NAND and DRAM chips compared to Qualcomm, and Intel's sales are more important in the PC sector. In addition, both companies' results are affected by factors such as China's slowdown and lower demand for NAND and DRAM.
In contrast, the 5G segment is still in its infancy, so Qualcomm's future earnings appear to be unaccounted for.