There is nothing better than buying a company that you wished you could have had cheaper... at the cheaper price. I'll admit, that while I've made some serious money making short-term, earnings/event driven trades on Qualcomm (QCOM), I have - deep down - wanted to own a substantial, long-term position. Qualcomm's business is a veritable money printing machine, and it employs some of the brightest business and technical minds on the planet. While I admire ARM's (ARMH) nearly hands-free royalty model, I just can't find myself willing to pay 53x CY2013E earnings for those shares. Luckily for me, I don't have to because I own Qualcomm - a very similar business, but one that generates a lot more cash, pays a fatter dividend, and has much more room to grow said dividend.
The Pessimism Explained
In the most recent quarter, despite a beat and raise quarter yet again, it seems that Wall Street was just so giddy that the analyst EPS estimates for the full year were well beyond the high end of the range that Qualcomm gave at its last earnings report. While I am somewhat kicking myself for not seeing this obvious disconnect and taking a short-term short position via puts, as there was very little chance that the company could have met those lofty expectations, I will not compound that mistake by not owning shares at these levels.
Anyway, so the full-year EPS "miss" against the projections is only part of the story of why the shares got hammered. There is a clear shift towards lower end, cheaper SoCs in the smartphone space. While Qualcomm, Nvidia (NVDA), and others have been trying to really "outgun" each other on high end benchmarks, the majority of the growth going forward appears to be in the low end, low cost segment of the market. Most people using feature phones don't care about their GeekBench or AnTuTu scores, but they do care that their phones can surf the web, make phone calls, and get e-mail.
So the thesis that seems to be playing out as Qualcomm's QCT operating margins slipped from 26% -> 17% in the most recent quarter is that with this dramatic mix shift towards the super low end, Qualcomm will not see particularly good operational leverage. On top of that, Qualcomm actually spends quite a bit developing its own IP from graphics, to CPU, to DSP, which is great for differentiating in the high end, but not particularly useful in the low end when an off-the-shelf ARM core, and off-the-shelf Imagination/ARM graphics will do the trick. In fact, Qualcomm's low end stuff indeed uses off-the-shelf ARM Cortex A7 paired with its own in-house graphics, modem, etc. IP.
In short, the top and bottom line growth in the QCT division may slow in the coming years, especially as competition like Intel and Nvidia kick in, but it is not as though Qualcomm is actually priced for that growth at a mere 17.71x earnings (13x ex-cash)! However, the real reason to own Qualcomm isn't necessarily for a meteoric top-line story, but instead for a very interesting dividend growth story.
Dividend Growth: Who Doesn't Love It?
Qualcomm recently raised its dividend from $1.00/share annually, to $1.40/share, which comes out to a pretty solid 40% increase. Understand that while Qualcomm's major growth business is chip, the company's earnings generator is from patent licensing. Every time a 3G or 4G enabled device is sold, Qualcomm gets a 3-4% cut of the selling price of said device. Remember the comparison I made above to ARM? Those guys get maybe 1-2% of a $15 - $50 chip, tops, but Qualcomm gets 3-4% of every cellular device sold. In the most recent quarter, the chip business turned in $681M in earnings before tax, but the licensing business turned in $1.8B in earnings before tax. That, folks, is roughly $1/share just for kicking back and collecting royalties.
I expect that Qualcomm continues to grow the payout at a healthy clip, especially in light of the fact that the business isn't particularly capital intensive and that most of the EBT that the company generates these days ends up piling up on the balance sheet (the company now has ~$30B in cash and cash equivalents). Of note, Qualcomm didn't buy back any shares in the most recent quarter, which to me suggests that they would much rather return capital via dividends than via buybacks, although they really do need to start doing something soon otherwise investors could get cranky.
Qualcomm: Think About Buying It
In this bull market, it's tough to find anything that's even remotely on sale. Qualcomm is still, however, very much on sale after the recent drop, and on any pullback, this could be a solid dividend growth, as well as just plain old growth name to stick in your portfolio on this weakness.
Additional disclosure: I am short ARMH