Investors in Qualcomm (QCOM) continue to have a great time, as analysts at Citigroup see even further upside for the company amidst an increased adoption of 3G and 4G technology in smartphones. I agree with Citigroup as the adoption of 3G and 4G offers greater opportunities than the threat of lower average selling prices, competition and lower royalty percentages. I continue to be long term optimistic about the company's prospects.
Citigroup Turns Bullish
Citigroup upgraded their rating on Qualcomm from "Neutral" to "Buy," while attaching a price target of $88 for the shares. The target suggests that shares have some 20% upside from these levels.
Analyst Ehud Gelblum sees Qualcomm benefiting from the LTE launch at China Mobile (CHL). The complexity of LTE is accelerating with new major technologies being added to the standard on a continued basis. This allows Qualcomm's large R&D budget and head start in LTE to create an even bigger gap between the company and its competitors, according to Gelblum.
The 4G LTE adoption cycle should benefit Qualcomm as just 175 million, or 3% of the worldwide wireless subscribers, are on LTE by the end of 2013. This adoption is expected to increase towards 40% by 2018. As Qualcomm has no exposure to 2G, the company stands to benefits from the conversion from 2G towards 3G and 4G.
At the start of November, Qualcomm released its fourth quarter results for the fiscal year of 2013. The company ended the quarter with $29.4 billion in cash, equivalents and marketable securities. Qualcomm operates without the assumption of debt, for a very solid net cash position.
Revenues for the year of 2013 came in at $24.9 billion, up 30% on the year before. Net earnings rose by 12% to $6.8 billion in the meantime.
Trading around $73 per share, the market values Qualcomm at $123 billion, or its operating assets around $94 billion. This values operating assets of the firm at 3.8 times annual revenues and 13-14 times annual earnings.
Qualcomm currently pays a quarterly dividend of $0.35 per share, for an annual dividend yield of 1.9%.
Some Historical Perspective
Long-term investors in Qualcomm have seen solid returns, with shares more than tripling from levels of $20 at the start of 2004 to current levels in the low seventies. Shares are still trading below the peaks of around $90 per share, set amidst the internet bubble.
Between fiscal 2009 and 2013, Qualcomm has increased its annual revenues by roughly 150% to $24.9 billion. Earnings four-folded to $6.8 billion at the same time. Despite share repurchases in recent times, the outstanding share base of Qualcomm has not declined meaningfully in recent times.
Qualcomm's business model continues to result in very high earnings, in a rather capital light business model based on royalties to a large extent.
Its technology licensing arm, generates less than a third of total revenues, but reports almost 70% of operating earnings. Its relevant wireless patents generate impressive royalty rates of up to mid single digits of average selling prices of smartphones. Given the still high prices for these phones, notably Apple's (AAPL) iPhone line, these royalties are substantial. As such, Qualcomm simply has to enforce these royalties, after which it receives solid cash flows on the back of past efforts.
The communication technologies business, which is the majority of Qualcomm's business in terms of revenues sells modems and connectivity, and this unit is actually responsible for the revenue acceleration in 2013.
Of course this beneficial position, on the back of the large patent portfolio, won't last forever mainly due to competition and changing technologies. The shift towards LTE will create a much greater base on phones being sold on which Qualcomm can collect royalties. At the same time, royalty percentages and average selling prices might come under pressure.
The net effect of this will likely still be positive, so the impact of competition will be determining the real impact on Qualcomm's cash cow. Yet competition is far behind on the curve, and it seems for now that only Intel (INTC) has the potential to create competing offerings, even as it will take some time to grab market share from Qualcomm.
Back at the start of November, I last took a look at Qualcomm's prospects following the release of its fourth quarter results. Shares have risen some 10% ever since despite a relative soft outlook into the first quarter. The current valuation values Qualcomm at 3.4 times annual revenues and nearly 13 times earnings. Note that this is after backing out the net cash position of the firm.
I noted that Qualcomm holds dominant positions being a major suppliers to both Apple and Samsung, which dominate the smartphone industry. Qualcomm continues to see adoption of 3G/4G to outpace competitive pressures and average selling prices, still resulting in long-term profitable growth on the back of very low cost of incremental sales in licensing.
As such investors should take comfort in Qualcomm's guidance of double digit revenue and earnings growth for the coming five years, providing a lot of visibility for future growth. This should furthermore provide a solid base under the current valuation. Combined with solid cash flows to shareholders and an incredibly strong balance sheet, I am quite optimistic.
I reiterate my stance, I still like the long-term outlook for Qualcomm as it holds dominant positions in an industry poised for future growth.