Chip Shortage: Qualcomm Leaves Money On The Table

Summary

• Even with Apple’s return and Huawei’s exit, Qualcomm still missed Q1 revenue and lowered Q2 guidance because of the chip shortage.
• As supply dictates demand, Qualcomm looks to increase 22% chip capacity from (1) Huawei’s freed 7nm capacity at TSMC, (2) Samsung’s 5nm fab, and (3) TSMC’s new 5 nm capacity.
• The consensus estimate of Qualcomm's 42% revenue growth cannot be supported by the 22% increase in capacity.  Thus, 20% of the 2021 orders may not be filled.
• Recognizing the chip shortage impact, Qualcomm's share has been traded at a 20%-30% discount to the analysts’ target price.
• The price discount suggests that the market underreacts to Qualcomm’s long-term growth prospect but overreacts to the short-term supply shortage.

(Source: Author's work)

Aided by Apple's (AAPL) return and Huawei's exit, Qualcomm (NASDAQ:QCOM) was able to deliver a better 2020 performance than other semiconductor firms. QCOM achieved a record $8.23 billion Q1 revenue, while under the pressure of a widespread global chip shortage. "If we could make more, we could sell it," said the outgoing CEO Steve Mollenkopf.

In terms of 2021 and on, "If you asked me, 'what keeps me up at night?' Right now, it is this supply chain crisis we're having in the semiconductor industry," said Cristiano Amon, incoming CEO of Qualcomm. Amon referred to the "V-shaped recovery" with a huge drop off in purchases, followed by a rapid return of demand. However, component manufacturers (like Qualcomm) couldn't keep up with the surge.

As the chip shortage clearly becomes the overriding constraint for Qualcomm's near-term growth, I intend to add more color on the chip shortage impact. In this post, it is estimated that Qualcomm may not be able to fill 15-20% of 2021 orders. While the company's guidance or analyst forecasts may not reflect the full extent of the chip shortage impact, Qualcomm investors have already discounted the stock by 30%.

2020 Demand Will Stay

In addition to the common WFH demand that all semis enjoyed in 2020, Qualcomm has been further blessed by the return of their largest customer, Apple, after the antitrust lawsuit. For Q4 2020 alone, Apple has contributed $571.73 million or 11.26% to Qualcomm's revenue (Bloomberg). In addition to Apple's favorable 5G iPhone sales outlook, Apple reportedly will use Qualcomm's 5nm Snapdragon 5G X60 modem in the upcoming iPhone 13 smartphones. Based on company's forecast, Apple's orders will become a permanent part of the Qualcomm future revenue stream.

As a result of the US sanction, starting September 2020, Qualcomm has further benefitted from Huawei's HiSilicon's exit for an additional 200 million handsets. "Now with the change in the market, we have kind of 16% of the market that was not available to us before being available. So, as we kind of look further out, we see this as a pretty material expansion of SAM (service addressable market) for us," CFO Akash Palkhiwala said on a call.

2020 Supply Shortage Will Worsen

While US sanctions against Huawei have shifted the smartphone demand to Qualcomm and other Android handset makers, the supply chain wasn't prepared for it. Notably, this has caused other brands like Oppo, Vivo, and OnePlus, to raise their stocks of its smartphones related components, further aggravating the situation and straining chip suppliers that have their sites running at full capacity. In terms of competing for the resulting chip capacity, Qualcomm's management considered the company "well hedged" due to its multiple chip sourcing. They also fully recognize that demand was outstripping supply as rivals of Huawei, which largely did not use Qualcomm's chips, will move in aggressively to take both Huawei's smartphone and chip market shares.

As per a Yicai report, smartphone chips are "completely out of stock." The Realme executive stated that Qualcomm's chips are out of stock due to supply issues with materials, power supply and radio frequency devices as well. Earlier in February, Xiaomi unveiled its highly anticipated Redmi K40 series made of true flagships with Qualcomm Snapdragon 888 and 870 chipsets. Xiaomi's major competitor in certain markets, Realme, is about to unveil its first 2020 flagship in the form of Realme GT 5G. Both companies acknowledged the fact that there is a huge shortage in the chipsets market.

Back in February 2021, Lu Weibing, President of Xiaomi, also added that the current supply issue is not a simple one, but an extreme shortage. As per a source close to the smartphone supply chain, Qualcomm's material deliveries for its chips have been delayed by more than 30 weeks. The delivery of its CSD Bluetooth audio chips have reached up to 33 weeks.

According to an industry analyst from Taiwan, "Currently, mobile phone processors, PMIC power management chips, and MCU microprocessor chips are all out of stock." Similarly, Han Jinman, executive vice president of Samsung's memory chip business, also stated that "As the supply shortage of chip foundries has become a global problem, the supply of other semiconductor components may affect the demand for mobile devices."

Qualcomm's New Chip Capacity

Per Bloomberg estimates, Qualcomm got (quarterly) $536.6 million 7nm chips, or 15.36% of its cost of goods sold, from TSMC as of 3/3/21. They also got $124.38 million, or 5.98% cost, 5nm chips from Samsung as of 9/4/2020 (Bloomberg Supply Chain). However, in order to support the rising revenue growth, Qualcomm must look for additional chip capacity from (1) the Huawei's chip capacity at TSMC, (2) the additional allocation of TSMC 5nm new capacity later 2021, and (3) the new 5nm capacity at Samsung.

Huawei's TSMC Chip Capacity

For the 16% smartphone market share just freed up, the corresponding $1.58 billion TSMC and $1.26 billion Samsung 7nm chip capacity will be up for grab. Given the existing contractual relationship between TSMC and its customers, it is unlikely that Qualcomm will also take over Huawei's 12.48% share of TSMC's capacity (Bloomberg Supply Chain).

TSMC's New 5nm Capacity

As Qualcomm's main shortage is on 5nm, a more promising prospect is from the newly created TSMC 5nm capacity available later of 2021. According to the supply chain, TSMC's 5-nanometer process has been mass-produced. The current monthly production capacity is about 60,000 pieces, and it is continuously expanding. It is estimated that the monthly production capacity will reach 100,000 pieces in the second half of this year. Qualcomm is expected to account for 24% of TSMC's 5nm chip manufacturing (Figure 2a). This is because Apple (TSMC's largest customer) will be using Qualcomm's 5nm Snapdragon 5G X60 modem in the upcoming iPhone 13 smartphones.

Figure 2a: TSMC 5nm Capacity Shares

Samsung's 5nm Capacity

Furthermore, just as TSMC started giving preferential treatment to Apple, as almost one-fifth of the company's total revenue comes from Apple, Qualcomm started to consider giving its Snapdragon 888 chipset manufacturing contract to Samsung. In return, Samsung has reduced prices for its 5nm process to solicit Qualcomm's order. Competition between Samsung and TSMC is expected to grow in the future, with the latter already projected to maintain its significant lead over the Korean firm. As both, TSMC and Samsung, increase their production capacity for the 5nm node, Samsung is expected to slightly catch up to TSMC, with the latter remaining the dominant foundry by the year's end. Specifically, Samsung's 5nm capacity is expected to trail TSMC's by 20% next year.

Finally, it is being reported that both TSMC and Samsung have already booked 90 percent of their 5nm chipset manufacturing capacity for the year 2021. They will continue to grow in 2021; however, at a much slower pace of roughly 5%. Although it is not clear if the new 5nm capacity is included, Samsung's relationship value with Qualcomm has increased from $21.46 million one year ago to $124 million Q1 2021. In 2021, Qualcomm is expected to have 12% of Samsung 5nm share (Figure 2b).

Figure 2b: Samsung 5nm Capacity Shares

Demand Growth - Capacity Growth = Unfilled Orders

Given the rising demand and worsening supply shortage, one way to assess the impact of the supply shortage is to estimate the demand/supply imbalance. As the global shortage will not improve in the short run, Qualcomm's demand is completely limited by the chip capacity they can get from TSMC (7nm) and Samsung (5nm). Assuming the analyst community has the same information in terms of Qualcomm's source of additional chip capacity, as listed above, their consensus forecasts should have factored in the impact of future chip shortage. So, suppliers' forecast of revenue growth can be viewed as a proxy for capacity growth, while Qualcomm's forecast of cost of goods sold growth is a proxy for future demand. The difference of future demand growth and the future capacity growth will indicate the extent of unfilled orders.

From this perspective, in Figure 1, the analyst average estimates for TSMC and Samsung's combined revenue growths (weighted by Qualcomm's cost %) are compared with Qualcomm's forecast of cost of goods sold growth rates (Bloomberg). The way to read this graph is that when Qualcomm's cost is estimated to increase at a higher rate than the suppliers' revenue growth rate, Qualcomm will have problems to meet all their estimated orders or sales forecasts. The difference will approximate the % of orders which will not be filled.

If you agree with this approach, Figure 1 is illuminating in many ways. First, largely since 2017, TSMC and Samsung have had higher revenue growth rates than Qualcomm's cost of goods sold growth rate, suggesting that Qualcomm didn't have supply shortage before.

Second, the only notable difference started Q1 (Dec) 2020 quarter when Qualcomm's cost increased by 69% (y/y), higher than the 20% of TSMC/Samsung revenue growth can support, indicating a 49% of the Q1 sales unfilled (or 25% unfilled between Q4 and Q1). This was also the supply constraint that Qualcomm stated as the reason to miss Q1's revenue.

More importantly, analyst forecasts suggest more intense shortage ahead in 2021. This is shown by the large discrepancy between Qualcomm's expected cost increase and the suppliers' revenue increase in fiscal Q2, Q3, and Q4 of 2021. For example, TSMC/Samsung are expected to grow their revenue, or to increase supply, by 21% in Q2 2021, which is far less than the 48% Qualcomm cost increase to meet its orders (Table 1). For the entire year of 2021, TSMC/Samsung can only supply about 21% more chips to their average customers, while Qualcomm will need 34% more to meet the forecast orders. For the first 3 quarters of 2021, Qualcomm will not be able to fill 20% of the forecast sales.

Why the Discrepancy?

There may be some explanations for the seeming unrealistic discrepancy, as analysts were supposed to reflect the supply shortage in their estimates. First, Qualcomm's cost increase may be overstated to reflect higher chip costs because TSMC has raised prices. However, that is also exactly the reason why discrepancy cannot come from the higher cost estimates, as Qualcomm has "long-term stable contractual relationships" with its customers and suppliers. Regardless, Qualcomm cost increase should be also equally reflected in TSMC revenue growth increase.

Second, analysts may factor in the likelihood that Qualcomm will take over all $1.58 billion of Huawei's capacity at TSMC. That will increase Qualcomm's TSMC cost exposure from 15.36% to 45%. However, since Qualcomm already has a full quarter of time (Q1 2021) to fight for Huawei's TSMC capacity against other chipmakers yet they still missed the Q1 sales, it is less likely that Qualcomm can negotiate to take a meaningful Huawei's share in TSMC's capacity in 2021. In fact, as TSMC has recently agreed to increase automobile chip production, by 15%, "as soon as the capacity is freed up," Qualcomm with less than 3% auto chip exposure may need to worry about losing some capacity of smartphone chip capacity.

Lastly, there is always a chance that analysts have not included TSMC's new 5nm capacity expansion, which Qualcomm has a 24% share, in the 2021 revenue growth estimates. Samsung 2021 revenue growth may be underestimated for a similar reason. But neither will be large enough to explain the 20% potentially unfilled orders.

Who Is Right? Analysts or the Investors?

Qualcomm has attributed the Q1 revenue miss to the chip shortage. The consensus Q2 estimates of $7.62 billion, an 8% drop from Q1's $8.23 billion, was supposed to reflect management's warning of 2021 chip shortage. The current large 20% estimated unfilled orders would suggest that both the company and the analyst community may have unwillingly understated the extent of the chip shortage impact. Thus, if it is possible that Qualcomm may not fill 100% of its 2021 analysts estimated orders, then it is highly likely that investors should expect future revenue misses.

The market pricing on Qualcomm shares also implies a similar discrepancy. If analyst consensus forecast on Qualcomm's revenue have not fully factored in the supply shortage impact, their target prices will be equally too high. At least for the recent months, QCOM shares have been traded at a 20%-30% discount to the analyst target prices (Figure 3). The discount may suggest that investors may see something that the company and the analyst community does not.

Finally, listen to what Qualcomm CEO said,

"We have all the supplies we need to meet a short term demand, but then that's going to go away, where to be in a position I am right now, which is, yes, I have a temporal ability to meet demand, but guess what, this demand is permanent."

You may want to take his first sentence with a grain of salt, but his last sentence is valid. Qualcomm has obtained Apple 5G demand and part of the Huawei's market share permanently. The current sharp price discount underreacts to the long-term growth prospect but overreacts to the short-term supply shortage. Qualcomm is truly "the cheapest names among tech."

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.