Qualcomm Banks On Strong Cash Flows To Return More Capital To Shareholders

| About: Qualcomm Inc. (QCOM)

Having ridden the mobile revolution to new highs, Qualcomm (NASDAQ:QCOM) rewarded its shareholders with the announcement of a 40% hike in quarterly dividends and a new $5 billion share buyback program. Qualcomm's shareholders are now eligible for a quarterly dividend of 35 cents a share, effective March 27, up from 25 cents previously. At the same time, investors will benefit from the bigger share repurchase program that replaces the existing $4 billion one, and shows the management's willingness to reinvest in the stock that is trading close to its all-time highs. The higher cash allocation to shareholders is due to the strong operating cash flows that Qualcomm has been generating over the past year. The company generated about $6 billion in operating cash flows in FY 2012, around 20% higher than the previous fiscal year.

Being at the forefront of technology innovations happening in the 3G and 4G world, the mobile semiconductor giant has benefited from the burgeoning demand for smartphones and other mobile devices. The company's unique business model allows it to profit from not only the sale of its own brand Snapdragon chipsets, but also the higher margin licensing fees that it derives from the sale of all mobile devices that can connect to 3G/4G networks.

While Qualcomm gradually faces increasing competition in the chipset space from rivals such as Nvidia (NASDAQ:NVDA), Broadcom (BRCM), and MediaTek, we expect the company to continue to leverage its early 4G LTE lead to good effect, going forward. Simultaneously, the rapidly growing mobile market ensures that Qualcomm will continue to rake in a steady stream of high margin royalties well into the future. Our $71 price estimate for Qualcomm is about 5% ahead of the current market price.

Sustained High Demand for Mobile Devices

The smartphone market has showed significant growth in recent years. Gartner estimates that almost 675 million smartphones were shipped worldwide last year, a growth rate of more than 43% over 2011. Consumer shift toward smartphones continues to be strong despite some lingering macroeconomic uncertainty, and it is likely that the momentum will push the smartphone market closer to the 1 billion mark by the end of 2013. At the same time, growth of other mobile devices such as tablets is picking up serious momentum. IDC estimates that tablet sales grew by over 65% in 2012 to 117 million units and will continue to grow rapidly for the next few years to reach about 260 million unit sales by 2016.

A big driver of the future mobile growth will be emerging markets such as China that are seeing an explosion in demand for 3G capable smartphones. IDC expects China to have increased its share of the global smartphone market by over 800 basis points to 26.5% in 2012, leaving the U.S. behind at less than 18%. With a billion strong mobile subscriber base and carriers increasingly trying to transition their huge 2G base to 3G, China presents a huge opportunity for Qualcomm to not only gain from its chipset sales, but also earn a steady stream of licensing revenues (see "Qualcomm Introduces Three New Entry-Level Chipsets To Target Emerging Markets").

We currently estimate that the 2G to 3G/4G transition will see 3G/4G penetration of mobile devices worldwide grow from about 50% currently, to a little under 70% by the end of the forecast period. However, growing adoption of smartphones in the emerging markets buoyed by the increasing number of low-end affordable smartphone options, could see 3G/4G penetration increase to about 80% by the end of our forecast period. Such a scenario would add a further 10% upside to our price estimate.

LTE Supremacy Will Help Ward Off Competition

Strong demand for smartphones is helping the cellular baseband market grow by impressive rates every year. Last year, the baseband market grew by a strong 18% year over year to reach about $18 billion. Qualcomm, which dominates the market with more than 50% market share, has benefited hugely from this trend. But the rapidly growing mobile device market has attracted the attention of a diverse set of semiconductor manufacturers, who are all vying for a greater chunk of the rapidly growing business in the coming years. This month alone, both Nvidia and Broadcom achieved significant milestones in their LTE plans. Nvidia announced its first LTE-integrated app processor, the Tegra 4i, and Broadcom introduced its first LTE baseband chip in the market.

However, Qualcomm has taken an almost monopolistic control over the nascent LTE baseband market. Of the 47 million LTE-capable chipsets that were shipped last year, Qualcomm accounted for nearly 86% of the market. This big lead is a testament to the company's superiority in 3G/4G connectivity solutions that helped it come to market first with LTE designs. As a result, while competitors are only now bringing their first LTE basebands to market, Qualcomm's chipsets are in their third-generation already. It is this maturity that the semiconductor giant brings to the table that caused Apple to shift its baseband supplier from Infineon (now acquired by Intel) to Qualcomm, back in 2011 when it launched the iPhone 4S.

So while we believe that the LTE transition gives the new entrants their best chance at competing more effectively with the market leader, Qualcomm's smart anticipation of the LTE demand and its proactive moves to get its basebands LTE-compatible, as well as integrate them on its Snapdragon app processors much before the rest of the market, have helped it ride the initial demand and should help it hold down the fort in the near term as well. Qualcomm's recent launch of RF360, which tries to solve the problem of LTE fragmentation by letting handsets work on most LTE frequencies, further solidifies the company's stature in the market and its ability to lead with first-to-market innovative solutions. Apart from Qualcomm's baseband supremacy, we expect its diverse set of customers and strong focus on power conservation, to continue to help it ride the mobile revolution for years to come.

Disclosure: No positions.