Seeking Alpha
Long/short equity, contrarian, deep value, event-driven
Profile| Send Message|
( followers)  

Qualcomm (NASDAQ:QCOM) has had an impressive stock market performance based on its enormous lock on smart connected device technology, monetized through both royalties and sales of processors and other components. The stock has risen 25% in the past year, outpacing the market.

(click to enlarge)

Qualcomm's earnings performance is equally impressive, with $8.6 billion of EBITDA in the past year contributing to earnings per share of $3.91.

(click to enlarge)

Source: Yahoo Finance

SA Author Ashraf Eassa was kind enough to point out that Qualcomm receives about $63 revenue per iPhone sold, about half of which is a royalty payment and the other half from components.

If this is so, and I have no reason to doubt Ashraf's excellent analysis, each iPhone sold contributes something like $50 of margin to Qualcomm assuming the royalties are 100% margin and the components are 60% margin, which can't be too far from reality.

Apple (NASDAQ:AAPL) is on track so sell about 160 million iPhones in calendar 2013, assuming it sells close to 55 million in its fiscal Q1. In rough terms, the iPhone thus contributes some $8 billion to Qualcomm's gross margin line. I think it is safe to say that Qualcomm's success depends to a great extent on the success of the iPhone, and for the time being that is looking pretty solid. In fact, and contrary to the point of view I put forward in my recent article "Is Qualcomm Volume Slipping?" for which I had my ears boxed by many who commented including Ashraf (and for good reason since I had simply forgotten the royalty stream Qualcomm receives from Apple), the current quarter should be very good for Qualcomm on the strength of the iPhone alone given the massive reception it seems to be receiving and the imminent launch of a China Mobile (NYSE:CHL) deal, widely expected.

I also wrote an article setting out the maturing nature of the smartphone market and its implications for Apple, again widely criticized by many whose economic future seems to hang on Apple's continued success or who just can't stand to hear anyone argue that Apple may face rough waters ahead. Notwithstanding, just as demographer and economist Robert Thomas Malthus dismally predicted the limits to population growth in 1798 to widespread criticism, I maintain there are demographic limits to growth in smartphones and, in the case of iPhones, those limits are near at hand.

In that article, I estimated that the ongoing level of iPhone sales would stagnate at about 160 to 180 million at most with a real risk they would actually decline not only in volumes but also in price as the competition in a mature market took its toll and prices fell as they typically do for all electronic devices over time. That eventuality will not only affect Apple but also will affect Qualcomm, if it happens.

For investors, the question is by how much?

For those of you who took the time to read my article on the affect of demographics on the smartphone market, you might recall that I suggested that rather than growing from its current 1 billion level worldwide the smartphone market is likely to decline to somewhere around 930 million devices post 2014. If it does, Qualcomm will see absolute volume declines in this space for its share of the 70 million device decline. If everyone held their current share of market, Apple included, the impact on Qualcomm would be about $1.6 billion less margin assuming Qualcomm receives $25 margin per smartphone on 90% of shipments. I have no idea if $25 per smartphone is a good estimate or a bad one but if you have better data you can do the arithmetic yourself and save yourself the trouble of disparaging mine. If the decline is combined with a disproportionate decline in iPhone sales, as I have argued elsewhere, the decline will be greater. The loss of 40 million iPhones, for example, would cut Qualcomm margins by $2 billion, based on the $50 per iPhone margin I guesstimated earlier.

The Apple bulls who accept the risk of a maturing smartphone market simply argue that Apple will invent some new "big thing" and it will continue its upward march in terms of sales and profits. Maybe that will happen. I don't know. But unless the new invention comes complete with a ton of Qualcomm content, it will not stem a decline in Qualcomm margins.

Qualcomm faces other risks as well, not the least of which is Intel competition. Maybe Qualcomm will fend of Intel and maybe not, but I would not dismiss it as a serious risk.

I have no position in Qualcomm but may buy some long dated puts once the euphoria over the current quarter iPhone success is fully into the market.

Source: Qualcomm May Follow Apple South As iPhone Volumes Decline In 2014 And Beyond

Additional disclosure: I hold puts on AAPL and calls on INTC