My investment thesis in Qualcomm (NASDAQ:QCOM) for a while predicted that the market was overplaying the negatives of the Chinese license issues and the impact of losing modem sales to the top smartphone company. The question now is whether the stock remains a buy as Qualcomm surges above $60.
The stock plunged to $42 and is up nearly $20 following the post-FQ3 earnings rally. The numbers were strong, but are long investors making the same mistake now focusing on the benefit of Chinese licensees?
The amazing part of the story with Qualcomm is that the upside produced during FQ3 was only part of the catch up. The company smashed analyst estimates in part because the market failed to factor in the benefits from the LG Electronics (OTC:LGEAF) license agreement signed in April that included $235 million in revenue catch up from the prior two quarters.
Amazingly, Qualcomm suggested that another $200 million in catch-up revenue from other smaller providers was included during the quarter as well. The $0.19 quarterly beat was primarily related to these license revenues though mostly known about that were not included by analysts in estimates.
The reason more upside exists is that the wireless chip company guided to FQ4 revenues based on the low end of the annual QTL guidance. Qualcomm suggests that the FQ4 guidance still leaves out $400 million of high-margin revenue. The CEO made the following in regards to a question from the Goldman Sachs analyst on the earnings call:
...in terms of the upside to guidance as we indicated our Q4 guidance is really set at the low-end of the full year range for QTL. So the upside would be the agreements in addition to the ones that we expect to sign that we put into the guidance. There is still $400 million of revenue upside that is possible for the quarter and not in our guidance.
Note that this upside is on top of guidance for revenue growth of up to 14% and earnings growth of around 20% at the midpoint. The QTL business is only targeted at $7.4 billion on the low end, quantifying the big impact of these Chinese deals that were very impactful, yet mostly a matter of when and not if.
The summary of the FQ3 results highlights the magnitude of the low-ball guidance the company typically provides. The estimates were as low as $0.90, when the company actually reported $1.16.
Source: Qualcomm FQ3 presentation
With the big rally, Qualcomm is now worth nearly $90 billion or the equivalent of an enterprise value of around $70 billion excluding the net cash position of nearly $20 billion.
The amazing part is that the stock remains cheap at a stock price of $61. Analysts forecast the wireless chip company earning $4.72 for FY17, providing for a 13x P/E multiple. Excluding the net cash position on 1,486 million shares, the EV multiple is a meager 10x EPS estimates.
All of these numbers don't factor in the upside potential for FY17 of the IoT opportunity and the fact that global phone sales will exit FY16 at up to 10% underreported. The FQ4 upside only places Qualcomm in a position where China finally exceeds 75% of reported phone sales with the country gaining market share.
Even after the rally, Qualcomm remains an exceptionally cheap stock. The stock is set up for another big beat in the current quarter with plenty of upside in the future as the business shifts toward the IoT and potential boosts in license revenue in that category.
Disclosure: I am/we are long QCOM.
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