Qualcomm (QCOM) has become the most valued semiconductor stock, beating Intel (INTC) due to its strength in the smartphone and tablet segment. The exponential growth in smartphones and tablets has led to a sharp rise in QCOM earnings, even as concerns about PC growth decline have led to a de-rating of Intel stock. Qualcomm stock has heavily outperformed other major hardware stocks like Cisco (CSCO) and Intel which have remained more or less stuck in a trading range. Qualcomm is a pioneer of the wireless communication industry and developed the CDMA technology, which powers most of the mobile phones in use today. The company owns a huge portfolio of patents related to the CDMA technology and manages to get a revenue share from almost all the mobile products sold today. The company also manufactures chipsets for smartphones and tablets and has got a substantial market share through its Snapdragon range of processors.
- Strong Presence in the mobile and smartphone markets - Qualcomm has been one of the biggest beneficiaries of the shift in the technology industry from PCs to mobile phones. With Apple shaking up the established hierarchy of the technology industry through iPhones and iPads, Qualcomm has benefited immensely. While Intel has seen its stock price stagnate, Qualcomm has seen a 55% increase in its stock price over the last 5 years. This is no mean feat for a company with a market cap in excess of $100 billion. As tablets and smartphones continue to grow at a fast clip, QCOM stands to benefit both by selling more products as well as licenses.
- Patent Power - Qualcomm gets the majority of its earnings from patent licenses and royalty payments. This cash flow is relatively safe as it is dependent on the growth of the mobile device market. Qualcomm also has a strong patent portfolio in the 4G LTE technology, which ensures that the cash will keep gushing in the future as well.
- Super margins, growing dividends and cash flows - QCOM's GM has decreased from the ~70% in the early 2000s to the ~60% range today. This is due to the expansion of the lower margin mobile semiconductor business. The Net Margin has been relatively unaffected and is still in the 30% plus range. The company is generating over $4 billion in FCF each year. While the current dividend yield of 1.7% is not that great, it needs to be remembered that QCOM has increased its annual dividend by more than 10x in the last 10 years.
- Strong Cash Position - Qualcomm has ~$24 billion of cash and investments on its balance sheet which forms almost 20% of its current market capitalization. The company is also generating almost risk free cash flow from its patents. These are very high quality revenues which go directly to the bottom line without any major corresponding costs. As long as the wireless communication industry grows, QCOM will grow right along with it. We do not see any disruptive wireless technology that could really reduce QCOM's patent revenue stream.
- Mobile Semiconductor Leader - Qualcomm is currently the leader in the mobile semiconductor market. The company's Snapdragon chipset is one of the market leaders in the tablets and smartphones segments. The company spends a massive amount of ~$4 billion every year to keep up its lead in the wireless space.
- New Communication Products - QCOM has shown in the past that it can quickly churn out a billion dollar business in a relatively short period of time (Snapdragon). While some of its products like "MediaFlo" have been duds, the company's technology strength allows it to introduce products which serve unmet market needs. The company recently came out with the Streamboost technology, which will allow routers to optimize the bandwidth between the different Internet devices.
- Fabless Issues - The Fabless strategy is being used by most semiconductor companies these days such as Nvidia (NVDA), AMD (AMD), and Texas Instruments (TXN). In this model, the actual production of chips is done by a 3rd party which is known as a foundry. This helps companies concentrate on their core strengths and leads to reduced capex and R&D expenditure. In the semi industry, this gives a huge advantage as technology upgrading happens almost every other year and a new fab can cost more than $5 billion. The huge expenditure on the semiconductor capital equipment is increasing as the dies become smaller and complexity increases. Only a few companies like Samsung (SSNLF.PK), TSMC (TSM) have the resources to spend ~$10 billion a year on fab equipment. The flip side of the fabless strategy is that you cannot ship more products in case of high demand. As fab capacity allocation on leading nodes is in high demand, customers cannot get this capacity on short notice. Also, if your foundry supplier is not able to upgrade, then you are in a soup as you cannot compete.
- Increasing Competition - Intel is making huge investments into R&D to make the move into the smartphone and tablet market. INTC already has a virtual monopoly in the PC and server processor market. Now the company is looking to go all out to become a big player in the mobile market as well. Qualcomm currently uses ARM (ARMH) based designs to build its Snapdragon processors. If Intel can come out with high quality processors with a low energy footprint, then QCOM will face a big threat in its core SoC market. Intel has bought the InterDigital (IDCC) wireless patents as well as Infineon's (IFNNY.PK) wireless chip technology business, to give it a leg up in this new business. Qualcomm also faces competition from Taiwan based Mediatek which makes application processors based on ARM designs. Cheaper Android tablets and smartphones use Mediatek processors in order to lower the prices. Broadcom (BRCM) which is another major mobile semiconductor player, has also introduced a LTE product to compete with QCOM in the mobile market.
Qualcomm's valuation is neither very expensive nor cheap, as the other companies such as Intel or Nvidia which are trading at bargain basement values. Qualcomm is relatively expensive compared to other semi stocks, with a P/B of 3.2 and a P/S of 5.6. However that is explained by its stellar margins - operating Margin of ~30% and net margin of ~32%. The higher net margin is due to the interest income that the company makes from its large cash pile. When compared to the broader market, the company's forward P/E of 14x is not expensive. However, when compared to Intel's P/E of ~10x, it is almost 40% more expensive. The company also has a decent dividend yield of 1.7%. Though not big enough to attract dividend investors, it is still a good bonus for shareholders who are getting a good stock price appreciation anyway.
Qualcomm's stock has outperformed the broader market and most of its chip competitors in the past 5 years with a return of ~55%. However, the stock has underperformed the Nasdaq by 4 percentage points over the last year. On a longer time scale of 10 years, QCOM has given a return of ~277% which is almost twice that given by Nasdaq. This performance is better than most of its competitors like Broadcom at 270%, Nvidia at ~217% and STM at -52%.
Qualcomm is one of the safest technology stocks because it gets the majority of its profits from the royalties and licenses related to the wireless communication industry. The boundaries between different form factors such as smartphones and tablets are disappearing. However QCOM is not affected, as it gets a royalty payment for the sale of almost every mobile product. The company is also in a dominant position in the production of the mobile semiconductor chips. Though the market is being threatened by the entry of powerful players like Intel, the company is also introducing new products to offset the potential decline in growth. The stock is currently trading just 5% shy of its all time peak of ~$68. We are impressed by the strength and stability of QCOM's royalty stream and would look to buy the stock during pullbacks.