Qualcomm (QCOM) reported second quarter revenue of $6.1 billion which was in-line with analysts' expectations. Its licensing business showed strong growth of 17.1% and posted revenue of $2.057 billion, above the consensus estimates of $2.04 billion. This was a result of increasing royalties on device sales of around 279 million units. It has further provided third quarter revenue guidance of $6.5 billion, and increased its full year revenue guidance to $24.5 billion from $23.9 billion.
Even after posting in-line results, its stock declined by 6%. Investors were mainly dissatisfied with the increasing operating cost which is affecting its margins. Though, its chipset division's revenue increased by 28% year over year, it is not really benefiting from it. The company saw its margin from the chipset division decline to 17.4% from 19.6% a year ago.
Investors are also worried that its high R&D investment will take a further toll on its margins. Currently Qualcomm is investing heavily in its "reference design program" to come up with less expensive but more power efficient products for emerging markets.
The Apple Factor
One of the reasons behind the softer third quarter guidance could become an opportunity for the company. Qualcomm had around 20% exposure in the second quarter towards Apple (AAPL). Apple is currently going for a product refresh and it is expected that it will launch several products in September and October including three new iPhones and two iPads. This caused deferment of purchases by the customers as they are waiting for the new products to be launched. And, in consequence, this has also reduced chipset shipment from Qualcomm, which had an impact on its third quarter guidance.
Apple is also facing pricing issues with its price leadership position being challenged. Its iPhone 4 and the lower storage version are seeing increased demand against its higher priced iPhone 5. However, Apple is in the process of launching two new mid-range versions of iPhones, one specific TD version for China mobile and one for the overall 3G market. Once these products are launched, the consumers will again start purchasing in earnest.
The China opportunity
More than 213 million smartphones were sold in China in 2012 which makes almost 30% of the total smartphone sales globally. China has a mobile subscriber base of around 1 billion, who are gradually switching from 2G based services to 3G/4G based services. Qualcomm had previously launched three new "Snapdragon" chips especially for the emerging markets. It has also developed a chipset named as "Snapdragon S4 Plus" which will help it to target the market from China Mobile (CHL). China mobile commands around 65% of the total Chinese subscriber base. It is in the process of transition from 2G to 3G network. The biggest issue for China Mobile is its proprietary 3G network "TD-SCDMA" -- as there are very few devices which support this network type.
Qualcomm's Snapdragon S4 Plus is capable of supporting not only commonly available 3G networks but also China Mobile's proprietary network. This can be win-win situation for both China Mobile and Qualcomm, as the device maker will look for S4 chipsets to leverage benefit from China Mobile's base. At the same time this will remove major hurdles which China Mobile is facing in expansion of its 3G network.
Talking about China Mobiles' 4G network, it is currently expanding its 4G network TD-LTE trial to 20 thousand base stations by the end of this year. As Qualcomm snapdragon devices are getting network certification, this could provide a huge opportunity for Qualcomm.
Additionally, Apple can also benefit from China Mobile, if it opts for these chipsets in its next set of iPhones. Apple couldn't target China Mobile's subscriber base for a long time due to incompatibility issues. But this chipset will open the door for the huge Chinese market, as it won't have to make any specific device for China Mobile.
Although Qualcomm's earnings were not well accepted by the investors, there remains good opportunity for investment, looking at the decline in its stock price. Qualcomm will see demand from Apple rebounding, once Apple launches its upcoming products.
On the other hand the huge Chinese market provides a better outlook for the company in the future.
Overall I recommend buying this stock at the current level for long term gains.