Qualcomm: 5G Is Huge, But Is Apple Sticking Around?

Summary

• The shipment of 5G phones and other devices is set to soar at the end of 2020 and in 2021.
• The use of Qualcomm products in the next iPhone will significantly boost sales.
• Trade tensions loom, but a new TSM plant will provide some safety in the future.
• This idea was discussed in more depth with members of my private investing community, Nail Tech Earnings. Get started today »

Co-Written with Elazar Advisors, LLC

Qualcomm (NASDAQ:QCOM) has been on a run despite the news of tensions between China and the US. Optimism around 5G has offset trade concerns. With the surge in 5G smartphones and other devices for the end of 2020 and 2021, Qualcomm can have significant upside.

Source: QUALCOMM Incorporated Stock Analysis & News

5G: The Main Catalyst

Most of Qualcomm's 2021 upside comes from the development and expansion of 5G. According to the company, 5G could deliver average rates of over 100Mbps. Also, traffic capacity could be increased by 100x, while reducing latency to 1ms, 10 times lower than 4G.

The upgrade from 4G to 5G is expected to be far more important than the upgrades to 3G or 4G. The ultra-fast speeds and low latency that 5G provides will be significant for many products.

Image Credit

The deployment of 5G in the US is well under way with all the main carriers. The FCC, with its 5G FAST Plan, is pursuing a strategy to help push the development of 5G. The plan has three components: pushing more spectrum into the marketplace, updating infrastructure policy, and modernizing regulations.

Smartphone Shipments

At the end of April, on their Q2 earnings call, management reiterated their guidance of 175-225 million 5G units for 2020. This assurance by management is very important given all the macro concerns. But since 5G will be the main growth driver for the company in 2020 and the following years, they can plow through macro concerns.

Source: Smartphone Challenges Continue in 2019, But 5G and Emerging Markets Will Bring Growth Back to the Market in 2020, According to IDC

From the chart above, we can see that 2020 and 2021 are the key years for 5G growth in devices. The number of shipments is set to increase exponentially, which is, of course, good for Qualcomm. Their 5G chips are higher value-added products than their 4G, so this should translate to higher revenues and earnings.

Internet of Things (IoT)

5G is not just about smartphones. 5G is also about driverless cars, edge computing, and more. Some of the most exciting technologies being developed at the moment are those related to the Internet of Things (IoT). 5G, by increasing speeds and reducing latency, will allow for new and better devices that are connected to the internet.

In simple terms, IoT refers to devices like sensors, wearables, and others that are all connected together via internet. In theory, the connection, as well as the automation of systems, allows these devices to gather and analyse information, share it, and take actions in real time.

We're already seeing more and more things connected to the internet. Smart homes, smart kitchens, smart TVs, etc. And more will come. In factories, schools, hospitals, etc.

Source: IoT market size worldwide 2017-2025 | Statista

So, this next-gen ramp is not just about smartphones. For comparison, according to the same source, the market size for smartphones in 2018 was $522 billion. So, by 2021, IoT market size could be around 80% of the 2018 market size for smartphones. The size of IoT is meaningful and will be an added driver to this and next year's results.

In the chart above, we can see that the market size of IoT devices worldwide will grow exponentially. In this huge and expanding market, Qualcomm will be a key player. They have the patents and the products to benefit from this growth. This can be one of the key growth drivers for the company along with smartphone sales.

The Apple Conundrum

Apple (AAPL) and Qualcomm have had their share of differences over the years. After a surprise settlement last year, the two companies agreed to work together on the next iPhone. Apple is expected to debut its first 5G iPhones this fall, powered by Qualcomm's X55 modem. This will be a huge revenue catalyst for the company.

Imagine, they are adding Apple to revenues. It's pretty huge.

However, according to a report by Fast Company, the partnership may not last long. The report states that the proposed antenna by Qualcomm is too large for the slim profiles Apple is aiming in future phones. On top of that, the report said: "Apple still feels it's getting screwed on royalties by Qualcomm." For these reasons, the report suggests that Apple is preparing for a split from Qualcomm.

Another article mentioned a similar view. The article quotes Apple CFO Luca Maestri saying: "As you know, we purchased the baseband activities from Intel. And obviously, we want to develop that technology because we consider it's a core technology for us." Apple wants to, ultimately, bring it in-house which is not good for Qualcomm.

It's something that needs watching for sure.

Short term, I think we're OK, but after this initial 5G ramp, we need to watch for hints of any shakeup in this relationship. If there are, we want to be far away from Qualcomm. Apple's too big and important to lose.

Apple bought Intel's modem business with plans to develop its own antennas and modules. Given the challenges of developing 5G modems and antennas, it's likely they will have to go with Qualcomm products for the time being. However, if they switch to their own chips in the future, a big part of the upcoming business for Qualcomm would go away. One source estimates the switch could be done by 2022 or 2023. It's not an immediate risk, but important to monitor.

Trade War Risk

The ongoing tensions between the US and China are another significant risk for Qualcomm and other semiconductor companies. If trade tensions escalate and measures by either government are taken, Qualcomm could be negatively impacted.

On May 15, plans by Taiwan Semiconductor (TSM) to build a $12B chip factory in Arizona were confirmed. TSM is a major supplier for Qualcomm, and having them produce in the US would be a safety net. It would reduce supply risks in case of a trade war or another event like the COVID-19 pandemic that can affect supply chains.

However, the plant is not yet being built. It will take some time for it to be up and running, so the risks are still there for Qualcomm in the short and medium term.

Model and Price Target

Based on the projected growth for 2021, we have a significant upside for 2021 (see full model: paywall). The inclusion of the X55 modems in iPhones, the growth in sales of other 5G phones, and the rise of IoT all provide significant growth opportunities for Qualcomm. Our model reflects that. Our projected EPS for 2021 is around $7.20 a share versus the Street at around $6.00. Using a PE ratio of about 19.5, our price target is $140 implying the stock has a 63% upside.

We have several requirements to give a stock our strong buy rating.

We need our quarters higher than the Street. We don't exactly have that but we'll be doing more work this month on Qualcomm.

We need more than a 45% 12-month upside. We have that.

We need wow, meaning the honest ability to say wow. 5G is a wow, but the trade and Apple concerns offset that.

Qualcomm falls a little short of those criteria required for a Strong Buy, but we are still bullish on the company's upside. We currently have a position in our model portfolio for subscribers.

Conclusion

Qualcomm has been on a nice run for the past month, and we believe it can continue to perform well in the short and medium term. Our model predicts a significant upside for 2021, given the surge in demand for 5G smartphones and devices, as well as the use of a Qualcomm antenna in the next iPhones. Overall, we are bullish on Qualcomm. That said, it's not an official buy rating for us. We think we have better ideas to get big. But Qualcomm's stock still has profit opportunities.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

All investments have many risks and can lose principal in the short and long term. The information provided is for information purposes only and can be wrong. By reading this you agree, understand, and accept that you take upon yourself all responsibility for all of your investment decisions and to do your own work and hold Elazar Advisors, LLC, and their related parties harmless. All model portfolio trades are hypothetical to show direction, conviction and timing. Performance excludes all relevant transaction costs. Opinions given are at this moment and can change rapidly after this is published. Elazar and its employees do not take individual stock positions to avoid front running and other potential customer related issues.

Comments

[sc21]

well time piece. tks sc

[flumeride]

It's silly to think Apple will have a modern to compete with QCOM. Many have tried and all have failed. The Intel modem was a joke. Apple throttled the qcom modems so they wouldn't vastly out perform the Intel modems. Intel couldn't wait to get out of the modem business.

What many people don't seem to understand is that modems are analogue and most other chips address digital. That is why Intel didn't perform well. They didn't have the expertise. Neither does Apple. 

Apple is at it's best when it uses existing technology and uses it in an innovative and creative way. They did that with the iPod. Others had cute little MP3 players, but Apple took it to the next level and the market exploded.

Then came the iPhone. It wasn't the first smartphone that could do email and store photos. But Apple expanded the smartphone and made it a tiny personal computer. Then they added the app store as a way for third parties to add value ... and pay Apple 30%. But Apple didn't invent any new technology.

The big reason Apple had a problem with QCOM is Tim Cook. He is a silly chain guy. He always has a second source available. Then he tries to bring the technology in house. ARM processors are a prime example. But he can't do it with modems. It drives him nuts. He would be much better off partnering with QCOM than trying to eliminate them as a supplier. He tried every dirty little trick with QCOM. Even orchestrating a hostile take over via Broadcom. He looked really bad and pulled out of the lawsuit before his all the evidence was presented about his royalty reduction plan.

So I don't fear Apple can change its dependence on QCOM products or royalties within the next 4 years.

I say ride both stocks. They are my two largest holdings and they are making me a happy investor.

[metoo5]

-- "It's silly to think Apple will have a modern to compete with QCOM. ... So I don't fear Apple can change its dependence on QCOM products or royalties within the next 4 years."

@flumeride - As I've said repeatedly, it's silly to think their goal is to compete with QCOM or that a 5G modem is a priority for them. Just look at the news. They're probably deeply involved in a 5+ year transition from Mac Intel to ARM, which is extremely complex and they're keen to expand the sales of the Apple watch by a factor of up to 10, and possibly future planned unannounced products. All of this is custom chip development alongside the software transitions to make it happen. The idea that the only thing that matters to Apple is the same thing as the main thing that matters to QCOM is pretty silly.

So your claim that we're unlikely to see a smartphone 5G modem in the next 4 years from Apple is a no brainer, as I've argued repeatedly. There's our common ground. But you'll keep insisting it must be a short-term goal and shouting FAIL, FAIL, FAIL every year it doesn't happen. That's how the game seems to work for you. Moreover, it's telling you're only willing to claim a 4 year gap. Surely you realize it's very unwise to invest in a stock on less than a 5-7 year time horizon. That's extremely short term. I regard investing on a 4 year basis something like swing trading. So your claim that they will be at least a 4 year gap doesn't sound very reassuring to LT investors.

[Dex4Sure]

Lol it's exactly the opposite. You cannot predict 7 years as accurately as say 2 to 3 years. 2-3 years is the ideal average time frame on my opinion and also from my experience. Sure, that doesn't mean that you always sell the stock after 3 years, but you have to keep reviewing the company regularly. It's always wise to take off some profits off the table. I certainly never invest into something blindly and just decide I should hold it for 7 years. It depends.

[sbally4]

QCOM 5G will be great going forward.

QCOM still gets the 4G and 3G Royalties that the new 5G devices will still be required to have.

[Eric Bradley]

Apple bought Intel’s modem business because intel could not make it work to compete with QCOM and exited the business. Apple may or may not have more success. BRCM failed and exited too. Basebands are hard. QCOM is best in breed. They will not go bankrupt without Apple, but I much prefer both of them working together.

Long both companies.

[when_to_sell]

Apple doesn't need a top notch, industry beating modem. They just need one that's not more than 12 months behind the leader. They've always designed with such modems and haven't had any problems selling their phones. So, in my opinion they'll do fine with their in-house modem. Even Samsung made their own modem, I'll bet Apple can.

[ccp4u]

Hahahahahahahaha...that is rich! If they could they would! The problem is that they haven't ,can't and my guess, won't. Did they pay billions and sign a long term agreement just to be nice?

[flumeride]

Samsung made their own modem and switched back to QCOM for the high end and either way they pay royalities.

[Ta0]

Thank you for this very informative article. Waiting on a pull-back to get back into $QCOM.

[Elazar Advisors, LLC]

I guess pullbacks always come. for now everything's only going up. :-)

[Ta0]

@Elazar Advisors, LLC
I held onto $QCOM for 10 years, and panicked right after March, when it dropped, so when it got back up to $75, I sold all my $QCOM. I made a decent profit because my purchase price was pretty low, but still...I'm pissed at myself for not hanging onto my shares. I want back in, but I need a pull back to get back in.

[Elazar Advisors, LLC]

Got you. Or instead of buying 100% lower, 25% here, 25% in a week or two, 50% at the lower price.

[Maverick 2021]

QCOM patent portfolio / royalties will get in the way of AAPL development and deployment of chip replacements. It is not a total disaster as AAPL would have many decisions to make, as legal considerations are warranted.
We know QCOM will protect it’s patent portfolio to the ends of the earth, given their long term view of product development. They should have already identified potential redesigns around their original patent. That is why they spend 5 - 10 years or more in R&D....?

AAPL is not the only smart people/company in and around Silicon Valley...?

[Elazar Advisors, LLC]

true. but still a warning to watch. also not imminent.

[Allinvestor]

How do you suggest watching it? Won’t it be too late when rumors/news comes out that Apple can develop it in-house or decides to part ways?

[TMFfan]

Apple is contractually bound to use Qualcomm's 5G chips on iPhones for the next four years, and beyond that is TBD.

[TMFfan]

Disagree with the article for the following reason:
1. When PYPL lost exclusivity with EBAY, people thought PYPL would be irreparably harmed -- no it was not -- as the opportunity ahead of it was bigger than just EBAY. Similarly, the 5G opportunity for QCOM is bigger than AAPL. QCOM will do just fine
2. Trade tensions with China especially the ban on Huawei benefits QCOM since the vendors who benefit from Huawei's demise will most likely be using QCOM products. Further, it makes no logical sense for China to ban advanced tech products like QCOM because their domestic industry would suffer hugely without the parts.

[MillionsDollarMan]

Huawei will come to terms with Qualcomm. First the back royalties will be paid. Then a 5G contract. That’s bigger than Apple win back.

[Guy at Work reading SA]

Only if Trump plays kindly with China will they sign a contract. Maybe phase 2.

[smackmybidup]

Apple is simply waiting for the appeal re QCOM antitrust ruling to play out. If QCOM loses, Apple will start making modems at their newly acquired Intel modem unit and will only have to pay QCOM royalties on the modem and not the phone. Apple hasn't changed its stance on getting screwed by QCOM royalties and will jump ship in a heartbeat if given the opportunity.

[Peder Steen Jensen]

That might be, but given how far Intel is behind TSM in process tech, I find it rather unlikely that Apple would be able to offer a product capable of competing with QCOM/TSM within the next years.

[Elazar Advisors, LLC]

true

[metoo5]

People are fixated on smartphones. I’d bet real money apples 1st modem is a tiny LTE modem for the Apple Watch. Ask google how depending on WCOM For wearables goes. A thinner better battery life smart watch will be a game changer. People always thinking of the last battle. There’s a whole world out there.

[jims11]

Real good article, cover all angles and pros and cons of owning this and other companies that have exposure to Apple and maybe impacted by macro events. I do have small position in QCOM, INSG and SWKS and trying to find safe way to add to companies with less negative exposure and more centric benefit of the 5G trend.

[Elazar Advisors, LLC]

QCOM's gone sideways for a long enough so that also removes some stock price risk.

[Peder Steen Jensen]

Why not TSM?

[jims11]

@ Peder,

I have that too, but not due to 5G trend only.

[David RG]

"Apple still feels it's getting screwed on royalties by Qualcomm"

So there is no option available to Apple that allows them to avoid paying Qualcomm royalties. It doesn't matter whether they (unlikely) are able to develop their own modem or not.

But most importantly, the statement is probably not accurate.

[Elazar Advisors, LLC]

Apple has been trying to bring in a lot of tech inhouse so quotes like that do flow with everything Apple's been racing to do. They cutoff QCOM thinking they could go it alone. It didn't work but the message was clear.

[metoo5]

-- "They cutoff QCOM thinking they could go it alone. It didn't work but the message was clear."

@Elazar Advisors, LLC - If the goal were to "go it alone" in the short-term it was pie, though not in the long-term as you acknowledge. Surely the most immediate proximate goal was to force QCOM to negotiate and get a better deal in the near term and to clear the decks for the long-term, which seems to have happened. The settlement was a mixed bag. There will be those claiming one side or the other dominated the other in the settlement, but I don't think people appreciate what was achieved. QCOM claims Apple got what it was always offered, but that's fairly absurd.

QCOM vigorously defended in court it's "no license no chips" policy. It's fate is still to be determined in court going forward, both in the appeal of FTC case and in future cases in the years to come that will be brought by corporations. Just look at what's happening in the automotive sector with cellular patents. The same issues are being fought. None of the issues QCOM has fought in court has gone away. What Apple got with their direct and separate contracts for chips and license is nothing less than an exemption from the "no license no chips" policy long before whatever happens in the courts in the years ahead. That is what they needed. It wasn't about money as much as developing their own stack just as Luca says. It matters little that they'll still pay royalties because it was never about the money. It was about freedom to develop their own modems for mobile devices (including wearables, which are much smaller than smartphones) without threat of lawsuit. If you don't think that's a problem, that QCOM would sue it's own licensees while they were developing their own silicon, just ask TI or consult the court testimony of a number of corporations–all public information–of them doing just that. It took Apple and Intel to do what no other company has ever done. That's what Intel's latest generation 7500 and 7600 chips did for Apple, and if not for that chip nothing would have changed. Seeing freedom from QCOM chips in the short-term as Apple's only goal is shortsighted. Think like stakeholders people.

Long term the problem for QCOM's royalty margins is going to be the partial summary judgment in the FTC case, where Koh ruled that the plain language of the IPR contracts for SEP patents–which they freely signed–requires licensing to competitors. Even if on appeal the FTC judgment is remanded back, that is extremely unlikely to be vacated. How would a court even do that? Even if they gut the case otherwise, how would they do that? Rule that all IPR contracts are null and void? That they don't mean what they say? As many analysts said at the time, QCOM has to get that partial summary judgment reversed. And yet, how could that possibly happen? That's the conundrum for them. Yes Apple will pay them royalties, as will everyone else. But the level of those royalties in coming years may not be as high as they've been in the past. If QCOM doesn't get the partial summary judgment reversed it's just a matter of time before lawsuits force the issue, and in that case if QCOM can't arrive at a fair price the courts themselves will eventually decide in separate cases. We're a long ways from the early dominance of QCOM's crown jewel, CDMA. Independent of Apple, this is another reason why the long-term case–beyond 5 years–for QCOM profit levels isn't as solid as many think.

[Elazar Advisors, LLC]

thanks.