Qualcomm Inc. (NASDAQ:QCOM) dominates the smartphone applications processor market with its 54% market share in terms of revenues. Apple (NASDAQ:AAPL) and Media Tek (OTC:MDTKF) hold the second and third positions with market shares of 16% and 10% respectively, while Intel (NASDAQ:INTC) is far behind in the smartphone chipset business with a market share of just 0.2%. Qualcomm's position is very strong and will drive its future growth, especially since a growing number of mobile carriers around the world are migrating to 4G LTE services.
Financial Performance for the First Quarter
In terms of revenues, Qualcomm performed well with record revenues of $6.62 billion, reflecting an increase of 10% for the first quarter of 2014 compared to the first quarter of the previous year. According to Qualcomm, the average prices for cellphones in the September quarter, used to calculate the licensing revenue for the company in the December quarter, were between $219 and $225, and resulted in a slight revenue growth of 2% compared to the fourth quarter of 2013. Primarily the growth is driven by higher than expected device sales reported by licensees and MSM chip shipments.
While a majority of Qualcomm's revenue comes from selling baseband chips that allow phones to communicate with carrier networks, most of its profit comes from licensing patents for its ubiquitous CDMA cellphone technology. The CDMA technology business contributed $4.62 billion and technology licensing contributed $1.9 billion towards revenues for the first quarter reflecting an increase of 12% and 8% respectively compared to the same quarter during the previous year. As phone prices decline, Qualcomm receives less royalty from revenues. It expects demand for its chips to grow later this year as leading mobile carrier, China Mobile (NYSE:CHL). rolls out cellphone services using the advanced LTE technology where Qualcomm dominates.
During the first quarter of 2014, Qualcomm shipped approximately 213 million CDMA-based MSM chipsets, reflecting an increase of 17% from the first quarter of 2013. This figure was far better than the company's guidance of a mid-point of 202.5 million. Average selling price (ASP) of a mobile handset with an built-in Qualcomm chipset during this quarter was around $219-$225.
Source: earnings presentation
The growth in the smartphone industry is moving away from developed markets such as the United States and towards China and other emerging economies where consumers favor less expensive devices. In the first quarter Qualcomm's profit margins received a hit and Qualcomm has been focusing on costs to preserve its profit margins.
On the GAAP basis, Qualcomm reported a net income of $1.88 billion reflecting a decline of 2% from the same quarter of the previous year. This decline is primarily is due to 20% higher research and development expenses, however, the first quarter net income increased by 25% compared to the fourth quarter of 2013. The diluted earnings per share of $1.09 remained similar to the same quarter of the previous year, whereas it gained a significant growth of 27% compared to the fourth quarter of 2013.
The liquidity and cash flow position is quite strong and during the first quarter of 2014 Qualcomm generated $2,781 million in cash from operations compared with $1,975 million in the same quarter of the previous year. Free cash flows were $2,571 million compared to $1,770 million during the first quarter of 2013. At the end of the first quarter of 2014, Qualcomm had $31,610 million worth of cash and marketable securities and no outstanding debt on its balance sheet, compared to $29,406 million of cash and marketable securities and no outstanding debt at the end of 2013.
Qualcomm extensively increased its research and development expense by 21% to develop CDMA-based 3G, OFDMA-based 4G LTE, and other technologies for integrated circuits and related software products to expand its intellectual property for the future growth of the company.
64-bit Smartphone Chipsets and LTE will Drive Qualcomm's Future Growth
LTE technology is gaining popularity around the world and with the advancement of the LTE network it is estimated that the TD-LTE subscriptions will reach nearly $1 billion by the end of 2020 and 2014 will see large scale commercialization of TD-LTE capable smartphones. TD-LTE device shipments will surpass 100 million in 2014 alone driven by recent and upcoming TD-LTE smartphone launches.
Globally, the shift to LTE technology is still in a preliminary stage. According to Qualcomm, around 2.2 billion mobile services subscribers around the world are currently still using 3G services and only 140 million are on 3G/LTE. To completely benefit from the LTE market Qualcomm, in collaboration with Ericsson (NASDAQ:ERIC), has recently moved ahead with its Qualcomm Gobi 9x35 which is an LTE Advanced Category 6 modem. This modem will offer up to 300 Mbps LTE advanced connection worldwide doubling the peak download speeds of the previous generation. Today life is moving at a fast pace and high speed internet connectivity is essential for everyday life. With the popularity of this modem Qualcomm will drive its sales growth.
Recently at Mobile World Congress 2014, Qualcomm introduced its quad-core Snapdragon 610 and octa-core 615 chipset for smartphones and tablets. These chipsets combined with an ARMv8-based 64-bit application processor and Adreno graphic engine and the category 6 LTE modem will start shipping during 2014. The LTE-inclusive solutions, like the RF360 chip that will be a part of the new Snapdragon 610 and 615 platforms, will drive robust demand for these chipset amongst high-end devices, resulting in higher earnings for Qualcomm. It will also maintain its market position especially as it moves from 3-mode to 5-mode global LTE with its third-generation LTE.
The 64-bit computing for smartphones is at its early stage but as smartphone makers are moving towards high-end 64-bit chipset based devices the competition amongst chip makers will increase for this platform. However Qualcomm's 610 and 615 platforms for 64-bit computing will give the company's portfolio another cutting-edge application processor option to go along with the top-end Snapdragon 800 and Snapdragon 801 package and the recently introduced Snapdragon 410 that is also a 64-bit solution. Samsung (OTC:SSNLF) and Foxconn (OTC:FXCOF) are Qualcomm's big customers and each account for more than 10% of its top line. Samsung recently announced its new high-end flagship Galaxy S5 that is equipped with the high performance chipset the Snapdragon 801. Looking at the history, Samsung's Galaxy flagships remained very popular with record shipments around the world and with this I believe Qualcomm will derive significant revenues during 2014. Sony (NYSE:SNE) Mobile has also announced its new flagship smartphone Sony Xperia Z2 and Sony Xperia Z2 tablet at MWC and both of these high-end devices are equipped with the Qualcomm Snapdragon 801. Since the typical high-end smartphones are priced above $500 Qualcomm will drive higher revenues from the shipment of these premium pricing devices during 2014.
Qualcomm's stock has a trailing twelve months dividend yield of 1.85% and with dividends of $0.35 per share for the first quarter. The company has increased dividends by an average 21% each year over the last three years. During 2013 Qualcomm repurchased shares worth $4.6 billion and in the first quarter the company repurchased $1 billion worth of shares. By the end of 2013 Qualcomm announced that the company would return 75% of its free cash flows to shareholders through share repurchases and dividend payments each year. According to the plan, the company intends to repurchase $4 billion worth of shares and $2.5 billion in dividends during 2014. This is quite an aggressive plan of returns to shareholders.
Qualcomm is very well positioned in the market and is expected to grow in the future. With the smartphone shipment crossing one billion units in 2013 and expected to double by the end of 2017, being the chip supplier to major market players in the smartphone industry the company is in a strong position to benefit from the market, through its highly competitive Snapdragon chipsets and newly introduced 4G LTE advanced embedded connectivity platform for mobile computing products. I believe Qualcomm will grow strong while maintaining its market leadership in the smartphone chip industry. Over the past twelve months Qualcomm's stock price has increased by 16% and I would suggest investors buy Qualcomm's stock.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by a Blackstone Equity Research research analyst. Blackstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Blackstone Equity Research has no business relationship with any company whose stock is mentioned in this article