Qualcomm: A Compelling Risk / Reward Story

Feb.24.10 | About: Qualcomm Inc. (QCOM)

Qualcomm (NASDAQ:QCOM) is a play on the smartphone space through its large intellectual property holdings related to 3G technology (there are six interfaces for this, of which three are based on Qualcomm’s CDMA technology and one on Qualcomm dominated OFDMA technology). Up to now, many GSM-based operators were using a bridging technology 2.5G (like GPRS), but the proliferation of smartphones and the explosion of data services means that the push to WCDMA (including HSDPA, HSUPA) will materialize, proving a big boost for Qualcomm.

Royalties make up 2/3 of the company's profits, while manufacturing chips makes up 1/3 of profits (with ratios switched for revenues). Having settled over the past 2 years all outstanding license agreements with the big guys for a 15-year period, Qualcomm has only one license renewal coming up in the next 7 years. This has obviously de-risked the business substantially. With +10% growth expected for the next 3 years with EBITDA growth of over 15% in the same period, the company is poised to reverse the flattish performance of the last year. Generating $1-1.2bn per quarter in the next couple years (which is $4bn of cash on top of the company's $19bn cash pile), the valuation seems out of whack with such an appealing profile for a large cap play. The company currently has a market cap of $67bn while the EV is $48bn. Ex-cash, you are getting the company at around 12x free cash flow multiple (or 14x P/E), on top of a modest 1.8% dividend yield.

The chart looks a bit eery as the stock hovers around the major support level at $37. With the potential to get back up to the $47 area (gap fill), however, risk/reward seems compelling at this level with a tight stop. (Click to enlarge)

Click to enlarge

Disclosure: Long QCOM