The share price of Qualcomm Incorporated (QCOM) rose the past few weeks after a bottom at roughly $59 dollars per share. Qualcomm is benefiting from the mobile revolution and revenues have been increasing at a double-digit pace the past few years.
Generally, Qualcomm is a cyclical company that should benefit from the low interest rate environment. At the very least, the share price should benefit from the low interest rate environment. Moving on to the historic relative total return performance, the historic total return performance is mixed. If you have been holding shares for 10 or 15 years, you are happy with the returns. If you have been holding shares for 5 or fewer years, you aren't as happy with the returns.
That brings me to my next point. Qualcomm is growing at a faster rate than the S&P 500, but the share price hasn't outperformed. That said, shares of the company are modestly undervalued. So, there is potential for Qualcomm to start to outperform the S&P 500.
The company is well positioned in the mobile industry; the financial performance forecast is excellent, and valuations are reasonable. I'm looking at getting long shares of Qualcomm. To me, this is an investment. It isn't a speculative trade; thus, I'm not planning on using a stop loss. The question for me is, what percentage of my assets do I want to invest in Qualcomm shares?
- The QCT segment derives a significant portion of revenues from a small number of customers, and Qualcomm may be unable to further diversify its customer base. In addition, the industry is experiencing and may continue to experience an increasing concentration of device share among a few companies, and this trend may result in an increasing portion of Qualcomm's revenues being derived from a small number of customers.
- The competition including (but not limited to) Broadcom (BRCM), CSR plc (OTCQB:CSRXF), Ericsson, Freescale (FSL), HiSilicon Technologies, Intel (INTC), Lantiq, Marvell Technology (MRVL), MediaTek , nVidia (NVDA), Renesas Electronics (OTC:RNECF), Samsung, Spreadtrum Communications (SPRD), Texas Instruments (TXN) and VIA Telecom.
- The royalty rates for single mode 4G products are generally lower than the royalty rates for 3G and 3G/4G multimode products, and therefore, Qualcomm might not achieve the same licensing revenues on LTE products as on 3G-based or 3G/4G-based multi-mode products.
- Qualcomm is being investigated by the SEC and the Department of Justice.
- The share price can go to $0 and investors can lose all of their investment.
- Qualcomm bought a stake in Alcatel-Lucent SA (ALU); I think it is a good idea for Qualcomm to take some risks with the cash on the balance sheet.
- Qualcomm's shares rose after earnings topped analysts' target.
- Qualcomm increased its quarterly dividend to $0.35 per common share.
- Qualcomm announced that its wholly owned subsidiary, Qualcomm Technologies, Inc., is enabling the world's first LTE-Advanced smartphone, the Samsung Galaxy S4 LTE-A, powered by the Qualcomm Snapdragon 800 processor. The Galaxy S4 is being launched in Korea.
- LG Electronics will utilize the Snapdragon 800 processor in the successor to the award-winning LG Optimus.
Qualcomm has four operating segments; two of them, QCT and QTL, generate almost all of the revenue.
The QCT (Qualcomm CDMA Technologies) segment develops and supplies integrated circuits and system software based on CDMA (3G), OFDMA (4G) and other technologies for use in voice and data communications, networking, application processing, multimedia and global positioning system products.
QCT's integrated circuit products and system software are sold to or licensed to manufacturers that use their products in wireless devices, particularly mobile phones, tablets, laptops, data modules, handheld wireless computers and gaming devices, access points and routers, data cards and infrastructure equipment, and in wired devices, particularly broadband gateway equipment, desktop computers, televisions and Blu-ray players. The MSM integrated circuits, which include the Mobile Data Modem, Qualcomm Single Chip and Qualcomm Snapdragon processor-based devices, perform the core baseband modem functionality in wireless devices providing voice and data communications, as well as multimedia applications and global positioning functions. In addition, their Snapdragon processors provide advanced application and graphics processing capabilities. QCT's system software enables the other device components to interface with the integrated circuit products and is the foundation software enabling manufacturers to develop devices utilizing the functionality within the integrated circuits.
The QTL (Qualcomm Technology Licensing) segment grants licenses or otherwise provides rights to use portions of the company's intellectual property portfolio, which, among other rights, includes certain patent rights essential to and/or useful in the manufacture and sale of certain wireless products, including, without limitation, products implementing CDMA2000, WCDMA, CDMA TDD (including TD-SCDMA), GSM/GPRS/EDGE and/or OFDMA standards and their derivatives, and QTL collects license fees as well as royalties based on sales by licensees of products incorporating or using the company's intellectual property.
QWI (Qualcomm Wireless & Internet) segment is comprised of:
- the Omnitracs division provides fleet management, satellite- and terrestrial-based two-way wireless information and position reporting and other services, software and hardware to transportation and logistics companies;
- the QIS (Qualcomm Internet Services) division provides content enablement services for the wireless industry and push-to-talk and other software products and services for wireless network operators;
- the QGOV (Qualcomm Government Technologies) division provides development and other services and related products involving wireless communications technologies to government agencies and their contractors; and
- the QRS (Qualcomm Retail Solutions) division builds and manages software applications that enable certain mobile commerce services.
The QSI (Qualcomm Strategic Initiatives) segment is made up of the company's Qualcomm Ventures and Structured Finance & Strategic Investments divisions. QSI makes strategic investments that the company believes will open new opportunities for its technologies, support the design and introduction of new products or services for voice and data communications or possess unique capabilities or technology. Many of these strategic investments are in early-stage companies. QSI also holds wireless spectrum. QSI's FLO TV division was presented as discontinued operations in fiscal 2012. All discontinued operations were attributable to Qualcomm.
That said, in the fiscal third quarter, the company shipped approximately 172 million Mobile Station Modem [MSM] integrated circuits for CDMA- and OFDMA-based wireless devices, an increase of 22%, compared to 141 million MSM integrated circuits in the year-ago quarter.
Total reported device sales were approximately $56.5 billion, an increase of approximately 18%, compared to approximately $47.8 billion in the year-ago quarter.
Worldwide wireless connections grew by approximately 2% to reach approximately 6.7 billion.
Worldwide 3G connections (all CDMA-based) grew by approximately 5% to approximately 2.1 billion, which was approximately 31% of total wireless subscriptions, including approximately 0.5 billion CDMA2000 1X/1xEV-DO subscriptions and approximately 1.6 billion WCDMA/HSPA/TD-SCDMA subscriptions.
According to the Global Mobile Suppliers Association [GSA], as of July 2013, to complement their existing 3G networks, more than 190 wireless operators have deployed and more than 390 wireless operators are planning to deploy OFDMA-based technology, often called 4G, in new wireless spectrum to gain additional capacity for data services. As a result, they expect continued growth in the coming years in consumer demand for 3G and 3G/4G mult-imode products and services around the world. In addition, they expect an increasing number of devices, such as computers, consumer electronics and networking equipment, to require multiple communications technologies to support a variety of connected applications.
The worldwide transition from 2G to 3G and 3G/4G networks is expected to continue, including the further expansion of 3G in emerging regions, such as China. Management expects that the emergence of lower-end smartphone products will contribute to such expansion.
Financial Performance Forecast
Qualcomm's revenue has been increasing at a pace that is above its long-term sustainable growth rate. That is attributable to the strong sales growth of mobile products. That said, for modeling purposes, I am going to use a growth rate of about 13%, which is roughly the sustainable growth rate. Also, there has been talk about slowing sales of mobile products.
There is one more quarter remaining in fiscal 2013; revenue for the year should be about $24.4 billion. Moving on to more important forecasts. For fiscal 2014, I am forecasting fiscal 2014 revenue of $27.8 billion. Operating income should be about $8.34 billion and net income should be about $7.98 billion.
The company should continue to return cash to shareholders. The dividend is safe, for now. And, I expect a scaled down share repurchase program. Shareholders may continue to have their equity stake diluted by increased shares outstanding. Overall, the financial performance forecast is bullish for the valuations.
Using a discounted cash flow approach to valuation, I estimate the intrinsic value of common equity shares of Qualcomm as $66.50. The share price at the time of writing is $64.50. Thus, Qualcomm is fairly valued based on the discounted cash flow model.
Discounted cash flow models are sensitive to changes in the assumptions. I have a preferred required rate of return; using that rate, the intrinsic value could easily decline to $20-$40 per share if the growth rate slows. But, using a lower required rate of return, one more consistent with a capital asset pricing model, Qualcomm would be significantly undervalued.
With a dividend growth rate of about 13%, a sustainable dividend growth rate of about 11%, and an environment of low interest rates, one can easily make a case that Qualcomm should be worth a lot more. Simply put, given the low interest rate environment and Qualcomm's high growth rate, Qualcomm is likely undervalued.
But, the growth rate, in the longer term, is too high and interest rates are too low. So, I would say at this level Qualcomm is fairly valued, but I would use declines to accumulate shares, based on this model.
Next, we'll use the justified value to value common equity shares of Qualcomm.
Based on my analysis of the justified value, Qualcomm is anywhere from 15.7% undervalued to 30.6% undervalued. To be fair, assuming the spread is wider than in my baseline model, Qualcomm is about 23% overvalued. To be on the safe side, I would use a decline in the share price to accumulate shares. That way, at worst (according to this model), you are buying shares at fair value. The baseline fair value is $69.80.
Next, using the 5-year average price/earnings ratio, Qualcomm is 40% undervalued; that would put the fair value at $90.44.
Using the price/book ratio, Qualcomm is 17% undervalued; that would put the fair value at $75.63. Next, using the price/sales ratio, Qualcomm is 27% undervalued; that would put the fair value at $82.08. Using the price/cash flow ratio, Qualcomm is 35% undervalued; that would put the fair value at $87.26. The average of those four fair values is $83.85; thus, using this model, Qualcomm is 29.7% undervalued.
Next, we'll examine the enterprise value. I estimate the enterprise value at $108.57 billion. Qualcomm is trading at an EV/EBITDA of 12.14, a fair valuation.
If we equally weight the discounted cash flow model, the justified value model, and the multiplier model, the fair value is $73.38. Qualcomm is undervalued by about 13.8%. Dips, declines in share price, should be used to accumulate shares, based on the valuations.