Qualcomm (QCOM) released earnings last week (see transcript) and while the market focused on their downward EPS revision for next quarter, it ignored the upward earnings revision for the year, which I believe is the number to focus on. My thesis on QCOM has me believing that there is at least a 30% upside in QCOM over the next year.
Company Overview: QCOM designs, manufactures products and provides services based on CDMA (3G) and OFDMA (4G) technologies. In layman terms, every cell phone or tablet that connects to a 3G or 4G network adds to QCOM's revenues because it either has a modem chip manufactured by QCOM, or if the chip is manufactured by another company, the cell phone manufacturer owes QCOM a percentage of sales as royalty for using the intellectual property that QCOM has invented and patented.
Revenue Analysis: Breaking down QCOM's 2011 revenues, about 60% of its revenues are from sale of manufactured integrated circuits and system software and 36% of revenues came from licensing of intellectual property. The rest of their business contributed to a relatively insignificant 4% of revenue. Recent reports suggest that QCOM's customer base is a who's who of the cell phone manufacturing industry. 13% of QCOM's revenues come from Samsung, another 13% from HTC, 5.8% from Apple (AAPL) and the rest is spread across LG, RIM (RIMM), Nokia (NOK) and Sony Ericsson. This revenue breakup makes the point that QCOM's fortunes are tied to the growth of the smartphone and tablet market.
1) Smartphone sales seeing aggressive global growth: According to a recent industry report, annual smart phone sales are expected to more than double by 2015 (go from 470 million units in 2011 to 1,048 million in 2015). Given that all smartphones are at least 3G enabled if not 4G as well, QCOM will directly see this growth add to its top line number.
2) Apple growth adds to QCOM's top line: We have seen AAPL's stock go parabolic on solid sales numbers for the iPhone 4S and the iPad. A lesser known part of this story is that AAPL used to use Infineon (IFNNY.PK) chips in its iPhones and iPads up until last year and in October of 2011 for the first time decided to use QCOM chips in its iPhone 4S. It then reaffirmed its faith in QCOM by using QCOM chips in the new iPad in March 2012. Hence, QCOM went from buying no chips from QCOM to becoming responsible for 5.8% of QCOM's revenues in less than a year. I expect the AAPL growth story to be a huge positive for QCOM and fully expect AAPL to become a much greater contributor to QCOM's revenues.
3) Windows 8 based laptops and tablets almost double QCOM's addressable market: If 2011 saw 470 million smartphones being sold, it also saw 415 million PCs sold. Of those, tablets, netbooks and notebooks made up 302 million. Windows 8 is expected to come out by the 2012 holiday season, is a tablet focused OS, and has had smoking reviews. Hence, I fully expect a large number of Windows 8 laptops, netbooks and tablets to contain a 3G/4G modem (much like the iPad). Additionally, for the first time ever, Windows will be able to run on ARM based processors as well, which means QCOM will be able to provide the main processor for these tablets, replacing Intel or AMD based processors. In fact Samsung, Microsoft (MSFT) and Qualcomm have already partnered to build Windows 8 based tablet prototypes and showcased them at the 2011 Microsoft Build Conference. Hence, I expect Windows 8 to be a big positive for QCOM's revenues.
While the above three are my main thesis points, I think it is worth mentioning a few other secondary points that will provide tailwinds for QCOM stock:
1) Growth in Windows Phone devices: QCOM is the only chipset supplier for Windows Phone devices at the moment. Sure the Windows Phone has not done well thus far, but Nokia is betting big on Windows based Lumia phones and any uptick in the Windows Phone market share will help QCOM.
2) Stock Buyback and dividend increase: QCOM announced a stock buyback on March 6th worth $4 billion to replace its previous $3 Billion buyback program, of which only $948 million of repurchase authority remained. This reaffirms QCOM management's belief that its stock is cheap. QCOM also hiked its quarterly dividend by 16%.
3) Historical performance and sell side consensus: QCOM has beat consensus EPS estimates for the past 8 quarters. Also sell side consensus target price is $72.32, which is a 13% upside from Friday's close of $63.91.
Risks: Sure enough no investment comes without risks. QCOM runs the risk of suffering from lower royalties if cell phone prices collapse, given its royalties is based on percentage of sale price. QCOM also has significant FX risk because most of its clients are Asian companies based in Taiwan, Korea, China and Japan. It is also exposed to macro-economic risks. Another global recession could dry up the global demand for more expensive smartphones.