Qualcomm: Sound Business Entering Period Of Uncertainty

Let’s talk Qualcomm (QCOM). The business is sound as 3G uptake is strong, chip orders remain solid, and the handset market is healthy. Cost improvements in chips should continue throughout the year. QCOM also expects to recognize some Pantech royalty revenue in 2nd quarter which helps the effective royalty rate and profitability.

Big dates coming up. Nokia/April 9th: QCOM's pessimism regarding a near-term resolution with Nokia has not changed. Although the companies will conduct another round of negotiations ahead of April 9th, there is a low likelihood that an agreement will be reached by then. If no agreement is reached, analysts would likely remove Nokia royalties from EPS estimate – the impact would be $0.06 in 2007 and ~$0.28-0.30 in 2008. While the headline multiple would change, it is important to remind investors that Nokia is willing to pay QCOM some royalties (analysts believe a 50% reduction in the rate would be acceptable to Nokia).

Broadcom/May 8th: The ITC hearing regarding remedy took place recently and press reports suggested it did not go as well as planned for QCOM. The final ruling from the Commission regarding remedy is due May 8th. If the Commission endorses the ALJ remedy of a ban on chipsets only, this would be a win for QCOM (which does not ship standalone chips across the border). If the remedy is extended to downstream products (ie. phones), this would be negative for QCOM. If that occurs, QCOM would look for a presidential veto and appeal the decision to the U.S. Court of Appeals. A few things to keep in mind include the FCC’s recommendation to the ITC not to ban downstream products and the effect such a ban would have on telcos, OEM’s, and ultimately, the consumer.

Despite the legal overhang, if you can take the risk you might want to own QCOM through this period of uncertainty. The company has strong fundamentals driving higher earnings and a possible NOK resolution in 2nd half 2007 driving multiple expansion.