Taken together, Apple (AAPL) and Qualcomm (QCOM) are the twin engines driving the smartphone market. The Apple business model demands closed, horizontal integration, where the company largely manufactures its own hardware and software. Alternatively, Qualcomm effectively functions as a workbench for the entire mobile, or wireless industry. Qualcomm and its team of engineers license out microprocessors to the likes of Dell (DELL), Nokia (NOK), BlackBerry (BBRY), and Samsung (SSNLF.PK).
Amid today's Web 2.0 Revolution, Qualcomm is the new Intel (INTC). Throughout the 1990's PC Revolution, Microsoft (MSFT) and Intel were both joined at the hip, as the ultimate foils to Apple. After Y2K hysteria came and went, however, the PC became a commodity. Today, Intel is effectively a utility stock that monopolizes its particular zero-growth niche, and pays out regular dividends. Going forward, Qualcomm shareholders are also set to emerge as victims of peak smartphone theory.
Peak smartphone Theory
Last May 2012, Google (GOOG) closed out its $12.5 billion acquisition of Motorola. This deal was largely touted as a defensive move - for patents that would protect Google's share of Android revenue against litigation. That following summer, a California jury ordered Samsung to pay $1.05 billion in damages to Apple to settle patent infringement charges. On September 21, 2012, Apple stock established an all-time high at $705, before share prices immediately broke down against a backdrop of a relatively weak iPhone 5 launch. Earlier this month, Apple cascaded down to a multi-month low at $450, while The Federal Trade Commission declared that Google should make its former Motorola patents available to competitors "on fair, reasonable, and nondiscriminatory terms." Evidence is mounting that the growth of smartphone market equity already peaked - during Summer 2012.
The smartphone, of course, is now the primary focal point of a Web 2.0 ecosystem that includes telecommunications, entertainment, audiovisuals, computing, and tablets. It is inevitable for the Web 2.0 ecosystem to track an accelerated business cycle of growth, maturity, decline, and bust. For Qualcomm, the march towards Web 2.0 maturity will also hamper the growth of the microprocessor market. Chip demand will be a lagging indicator, and Qualcomm is now running the risk of being saddled with inventory that cannot be sold off - without steep price discounts. This inventory effectively includes intellectual property, which may fetch lesser royalty payments due to flagging demand alongside intensifying competition from the likes of Nvidia (NVDA).
According to research firm Wireless Intelligence, 4 billion 3G-4G global connections will be established by the end of 2016, which is a significant increase in amount above today's 1.9 billion connections. Going forward, however, projections for the continued hyper-growth of wireless data transmissions through 3G and 4G networks may prove to be overly optimistic. Indeed, popular recording sensation Prince would command Qualcomm investors to Party Like it's 1999, as an encore to Intel and Cisco (CSCO) shareholders before them who also helped drive the PC and networking growth bandwagon into the ground.
Anything But Apple
Qualcomm now promotes its Snapdragon processor as its flagship product. The Snapdragon line is notable for powering rapid download speeds, organizing multiple applications, and presenting impressive graphics, while still remaining relatively cool - without a fan. Cooler temperatures preserve battery life for gaming, taking pictures, surfing the Internet, and taking calls. For smartphones, the premium Snapdragon S4 processor is now capable of maintaining up to 1.7 GHz in CPU, displaying graphics in 1080-pixel picture resolution, and taking pictures through the lens of a 20-megapixel camera sensor. Beyond smartphones, separate suites of Snapdragon processors also power tablets and flat panel televisions. The Snapdragon is now the effective "go to guy," for anybody but Apple, as evidenced by its installation within the latest premium Samsung Galaxy, Nokia Lumia, and BlackBerry 10 smartphone lines. At present, Nokia and BlackBerry are literally fighting for survival, which make their recent product launches all the more important - for both themselves and Qualcomm's bottom line.
On February 6, 2013, research firm comScore released its latest report for December 2012 U.S. smartphone market share. The comScore tables present averages for data taken from the October 2012 to December 2012 quarter. The Google Android and Apple iOS operating systems now control respective 53.4% and 36.3% shares of the smartphone market. This duopoly is still consolidating power, as evidenced by its collective 3% increase in share above the prior quarter. On the handset side of the ledger, Apple and Samsung headline this list as the top two original equipment manufacturers operating in the United States of America. At the bottom of the heap, BlackBerry, Nokia, and Microsoft Windows are desperately fighting over table scraps while attempting to preserve small shreds of relevance as telecommunications operators. This is a game of musical chairs - where Google and Apple already own two out of the three remaining seats in the room.
For Qualcomm to sustain hyper-growth, it must encourage increased acceptance of Google Android, BlackBerry 10, and Windows 8 operating systems - largely at the expense of Apple iOS. Any projections assuming the expansion of Google Android market share beyond 60%, or even 55%, are unlikely, if not laughable. Alternatively, a recent Verge review awards BlackBerry 10 with a solid, but uninspiring seven out of ten rating. According to The Verge, the BlackBerry 10 operating system lacks a "killer app." Without a "killer app," BlackBerry 10 may fail to gain traction in the U.S. market. Prospective Qualcomm investors can confirm a BlackBerry 10 flop, when the company begins hawking formerly premium Z10 phones at steep discounts in India. Lastly, Nokia reported that it sold 4.4 million Lumia 920 phones during its latest quarterly period ended December 31, 2012, which was up from the prior quarter when the company sold 2.9 million units. This increase in sales is likely an anomaly, where Nokia leveraged the perfect storm of Holiday Season timing alongside Apple iPhone 5 supply chain inefficiencies.
The Bottom Line
Over the past six months, Apple, Nokia, and BlackBerry positions have all been notable for their extreme volatility, as the smartphone market lurches towards inevitable commoditization, deteriorating profit margins, and industry consolidation. For Qualcomm shareholders, the rhythmic interplay between speculators, technology industry journalists, and short sellers is the canary in the coalmine symptomatic of a stalling mobile device market. As a supplier, Qualcomm will be last to feel the contagion. Original equipment makers will be forced to curtail orders for chips and wireless software, as inventories pile up. Next, intellectual property royalty payments and valuations must be written down to reflect market saturation and flagging demand. Qualcomm shareholders should consider quitting while ahead, selling stock, and taking profits, before this stock degenerates as the latest shoe to drop in the Web 2.0 space.
Wall Street valuations assume that Qualcomm will maintain hyper-growth well into the near future. On February 21, Qualcomm stock closed out the trading session at $65. According to Wall Street, Qualcomm is now worth $110 billion in market capitalization. For last fiscal year ended September 30, 2012, Qualcomm reported $6.1 billion in net income. At current levels, Qualcomm trades for eighteen times trailing earnings. Over the past four years, Qualcomm is averaging impressive 35% net income growth, despite the fact that diluted earnings per share collapsed from $1.90 to $0.95 between 2008 and 2009, largely on special charges. Without this one-time anomaly, Qualcomm averaged 65% annual diluted EPS growth from 2010 to 2012. Qualcomm is undervalued, only if it were to maintain growth at this torrid rate.
All great things, of course, must come to an end. The $19.1 billion in Qualcomm 2012 revenue is classified further into $12.5 billion in equipment and services and $6.6 billion in licensing. Geographically, the lion's share of Qualcomm's deals are actually closed out in Asia, as sales in China, South Korea, and Taiwan accounted for roughly $15 billion, or 80%, of this company's total $19.1 billion in revenue. Between 2011 and 2012, United States revenue figures remained nearly flat, while the "other foreign" collective group declined during this time frame. Qualcomm's bottom line results will deteriorate rapidly, when China grinds through an inevitable slowdown. Meanwhile, U.S. sales will remain insignificant, as recent product launches out of Samsung, BlackBerry, and Nokia have largely failed to capture the imagination of Americans and dramatically reorder the smartphone marketplace away from the Apple iPhone platform.
Apple shareholders who stubbornly clung to shares that collapsed from $705 to $450 within six months would sternly advise Qualcomm cheerleaders to get out now, while the getting still seems good.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.