Qualcomm Inc. (NASDAQ: QCOM) Memo

Transcription

1 Date: 12/1/09 6/29/10 Company: Qualcomm Inc. Price: $45.06 $33.14 Analyst: Zhengwei (Will) Liang 12/1/ Week Market Price Range Cap $45.06 $ $49.80 $54,360 Revenue 5,673 7,526 8,871 11,142 10,416 Growth 32.7% 17.9% 25.6% -6.5% Equity Value $54,360 EBITDA 2,586 2,962 3,266 4,186 2,861 Net Debt $11,069 Margin 45.6% 39.4% 36.8% 37.6% 27.5% TEV $43,291 Net Income 2,143 2,470 3,303 3,160 1,592 EPS $1.31 $1.49 $1.99 $1.94 $0.96 P/E Multiple (ttm) 17.7x Short Interest 1.40% Growth 13.7% 33.6% -2.5% -50.5% (% of Float) Multiple 56.4x 25.4x 19.8x 18.5x 48.2x Business Description: Qualcomm (QCOM) is a leading provider of wireless technology and services around the world. Despite offering a wide range of products and services through various business segments, over 90% of QCOM s total sales come from its 2 core revenue generating segments. Qualcomm CDMA Technologies (QCT) develops and supplies CDMA-based integrated circuits and system software for wireless products (59% of total revenues). Qualcomm Technology Licensing (QTL) grants licenses for the use of its intellectual property, which includes patent rights essential to the manufacturing of many wireless products (35% of total revenues). Investment Thesis: As an excellent top-down, bottom-up, growth, and value play, I believe that QCOM has the potential to be a great 3-5 year investment. QCOM boasts a significant competitive moat, a leadership position in innovation, excellent growth potential, and solid financials. QCOM s sustainable competitive advantages place it in a unique position to benefit greatly from rapid wireless industry growth in the near future. QCOM currently trades at $ Based on a DCF analysis, I believe that QCOM s shares have an intrinsic value of $48, yielding a generous margin of safety of 45%. Misperception: QCOM s share value has been depressed significantly since January 2010 due to what my fundamental research suggests is an overreaction to its management lowering earnings guidance for 1Q Shares fell over 25% between January and March 1 st and are now trading at around a new 52-week low of $ Hype regarding upcoming 4G has caused 3G and CDMA to go out of favor with most growth seeking investors. However, I believe QCOM s current price provides a great opportunity for a value seeking investor to buy an excellent company at a significant discount. Most Compelling VAR: Experienced Wireless Industry Employee: Steve Henry, Retail Sales Manager, Verizon Wireless 4G may be the new cool thing, but it s still going to be 3G CDMA growth that drives this industry for years to come. o Expect 3G to stay around for a while, as Sprint only recently launched what we like to call a quasi-4g network. o Essentially all of the phones we sell use Qualcomm CDMA chips. Smartphone sales are better than ever. Even 15 minutes before closing, a dozen customers were still shopping in the Verizon store. o We sell well over a dozen smartphones on any given day. o Now that the economy s getting better, many people are making that upgrade that they held off on during tough times. Key Thesis Points Intellectual Property Rights Create a Competitive Moat: QCOM holds more than 12,000 US patents for wireless technologies, the most in the industry. A majority of these patents involve various aspects of CDMA, a superior technology pioneered by QCOM, which has become the basis of all major 3G standards. As a result, other companies in the wireless industry cannot create CDMA based 3G products without the use of QCOM s patents. QCOM generates significant revenues by licensing its patents to other companies and collecting royalties through its QTL segment. QTL has margins of 90% and makes up over 60% of net income. QCOM s powerful intellectual property portfolio clearly creates a competitive moat, as there is simply no way to compete on an equal playing field with QCOM in CDMA technologies. Consistent Leader of Wireless Innovation: For years, QCOM has been the driving force behind much of the technological innovation in the wireless industry. Its ability to develop and patent groundbreaking innovations essentially ignites the wireless industry value chain. For example, QCOM s state-of-the-art chipsets allow handset manufacturers to create highly demanded phones, while service providers benefit from QCOM s CDMA technologies due to cost decreasing spectral efficiency. With better products, end customers demand more, which fuels the growth of the entire industry. While all players in the value chain benefit, QCOM ultimately benefits the most due to its leadership position. Developing new technologies is much harder than using them, which makes for significantly higher barriers to entry at QCOM s level of the value chain. QCOM s accumulated experience, which is represented by numerous patents and trade secrets, separates it from potential competitors.

2 Exceptional Growth Opportunities: QCOM is positioned very well for growth due to its sustainable competitive advantages. o Growth in 3G Smartphone Demand: Smartphone shipments, as a percentage of total mobile phone shipments, are expected to double by 2014 globally. QCOM is in a unique position to benefit because 80% of phones with 3G capability use CDMA technology. QCOM makes an approximately 5% royalty fee on 4 out of every 5 phones sold. In addition, a significant amount of smartphones use QCOM chips. Manufacturers such as LG, Samsung, Motorola, Research in Motion, Nokia, HTC and more all have chip agreements with QCOM. QCOM s Snapdragon chipset allows other manufacturers to compete with Apple s iphone. VAR shows that, despite the iphone s strong brand image, most buyers would opt for a more powerful device at a similar price. The overall increase in smartphone demand will drive revenue growth for QCOM, while the potential exists for an added boost if QCOM powered devices capture significant market share from Apple. Credible rumors also suggest that Apple may release a phone for Verizon featuring QCOM s chip. o Growth in Emerging Markets: Emerging markets with less developed 3G networks, such as China, India and South America, present enormous growth opportunities for QCOM. From , CDMA subscribers are expected to grow ~584% in China, >200% in India, and ~542% in South America. QCOM makes royalties on every CDMA phone sold globally, so rapid growth in emerging markets should make a profound positive impact on QCOM s earnings. In addition, QCOM is making efforts to accelerate the expansion of 3G in certain high potential markets. Recently, QCOM spent $1 billion in an Indian 3G spectrum auction. Its plan is to partner with an Indian service provider to accelerate the deployment of 3G networks. Once the networks are available, QCOM essentially bets that mobile device sales will follow. o Growth through Expansion into Adjacent Product Areas: QCOM is currently working on several new initiatives in adjacent product areas that leverage its innovative capacity and expand on its core technologies. For example, QCOM is currently looking to expand into the fast-growing netbook/smartbook/tablet PC segment with its new dual-core Snapdragon processor. VAR suggests that the Snapdragon chip is expected to toast benchmarks everywhere. QCOM is also pursuing other new products such as FloTV (mobile TV platform), Mirasol (ultra high-efficiency display technology), Gobi (built-in mobile broadband technology), Brewmp (mobile operating system), as well as various services. Extensive R&D is built into QCOM s business model, so these new initiatives do not push QCOM beyond its means. Although revenues from non-core product areas do not currently make up a material portion of QCOM s total revenues, the potential for growth in these areas adds an exciting x-factor with a promising upside. Strong Financial Position: With a considerable cash balance of 11.6B, QCOM can make key strategic acquisitions if a smaller company develops valuable new technologies in a particular area. An example of this would be when QCOM acquired Flarion in 2005 to strengthen its 4G intellectual property portfolio. Furthermore, QCOM delivers value to shareholders through cash dividends (2.2% annual) and a structured share buyback program. QCOM also operates with high solvency (no debt) and liquidity (current ratio of 3.8), making it a less risky investment. In addition, it s worth noting that QCOM boasts industry leading operating margins (31.71%) due primarily to its licensing business. As the licensing business grows, high margins will transfer revenue growth into significant earnings appreciation. See Appendix 12 for a financial metrics comparison between QCOM and its competitors. Valuation: QCOM currently trades at a p/e multiple of 17.7x ttm earnings. This is significantly below the industry average multiple of 24.6x. Considering QCOM s unique advantages and competitive moat, it should be trading at a multiple at least equal to the industry average. Based on consensus 2010 forward earnings of $2.32 and the industry average p/e of 24.6x, the fair value per share is $57. Furthermore, a DCF analysis resulted in a target price of $48.11, yielding a generous margin of safety of 45%. How it Plays Out: 3G CDMA mobile device sales increase and devices powered by QCOM s Snapdragon chip capture market share from Apple. QCOM s $1 billion 3G venture in India catalyzes 3G device sales, leading to increased royalty revenues. QCOM successfully enters growing adjacent product areas, establishing a significant new stream of revenues. The market will soon get over QCOM as solely a growth story and fully appreciate it as a sustainable enterprise of great value. QCOM will beat conservative earnings estimates in the upcoming quarters and dominate tech industry headlines with the growth and success of its technologies, forcing the market to make valuation adjustments. What Would Make us Wrong (i.e. risks)? Other Considerations? New Radical Technology Makes QCOM's Research and Products Obsolete: QCOM s competitors could introduce technologies that are superior to those of QCOM. However, QCOM has always been at the forefront of innovation in the wireless industry, and this trend is expected to continue. QCOM is currently very well positioned for both 3G and 4G standards. Drop in Royalty Rates After Adoption of 4G Technology: Royalty rates for the use of QCOM s patents are expected to drop to 3.25% of the price of 4G phones versus 4-5% for 3G phones. However, 3G penetration is far from being complete in most markets, and it will be more than 3 years before 3G phone sales experience any kind of decline. 4G phones will also initially be more expensive. Antitrust Litigation: QCOM s use of intellectual property has historically been the target of antitrust legislation. However, the effects of such litigation on QCOM s operations have been immaterial, as they generally result in reasonable settlements. Industry Adopts Technical Standard that does not Utilize QCOM s Technology: It s still uncertain as to which 4G standards will be primarily used. However, although QCOM may not have the dominance in 4G as it does in 3G, it will still own a significant amount of important patent rights regardless of which 4G standards are eventually used.

3 Appendix 1: VAR Contacts Name Position Contact Info Steve Henry Retail Sales Manager, Verizon Wireless In Person (Verizon Store: Midlothian, Va) Barbara White Retail Sales Representative, Verizon Wireless In Person (Verizon Store: Midlothian, Va) Bill Hinkle Retail Sales Representative, Verizon Wireless In Person (Verizon Store: Midlothian, Va) Casey Smith Manager, Best Buy Mobile In Person (Best Buy: Midlothian, Va) Brandon Marsh Consultant, Best Buy Mobile In Person (Best Buy: Midlothian, Va) Jasmine Vargas Lead, Best Buy Mobile In Person (Best Buy: Midlothian, Va) Garrett Carter Mobile PC Sales Representative, Best Buy In Person (Best Buy: Midlothian, Va) Jenny Rebate Customer Service Rep., Verizon Wireless Mike Li Senior System Performance Engineer, Verizon Communications Arvind Prabhakar Technology Licensing Financier, Qualcomm Robert Beard Strategic Planning Manager, Intel Mason Cabot Hardware Engineer, Intel Rahul Gorawara Analyst, Rivanna Capital, Charlottesville, VA Minhaj Patel Senior Analyst, Magnetar Capital Sangbum Kim Analyst, BH Asset Management Roy Chung Qualcomm Product User and Wireless Enthusiast

4 Appendix 2: One-Year Stock Chart Qualcomm Inc. (NASDAQ: QCOM) Memo Appendix 3: Stock Summary

5 Appendix 4: Qualcomm s Unique Position in the Wireless Technology Value Chain Appendix 5: Sales in CDMA based 3G Mobile Devices are not expected to Decline Anytime Soon

6 Appendix 6: Sales of CDMA based 3G Mobile Devices will continue to Outpace Total Handset Sales Appendix 7: Promising Growth in Emerging Markets

7 Appendix 8: Qualcomm Maintains Key Relationships with Major Mobile Device and Smart Phone Manufacturers Mobile Device Manufacturers: Smart Phone Manufacturers: Appendix 9: Increase in Sales Volume has Compensated for the Decline in Mobile Device Average Selling Price

8 Appendix 10: Qualcomm s Efforts in Expanding Core Technologies to Adjacent Product Areas Appendix 11: Qualcomm is Increasing Valuable R&D Expenses While Successfully Containing Other Expenses

9 Appendix 12: Competitor Analysis % of Revenues from Mobile Devices Segment Qualcomm Inc. (NASDAQ: QCOM) Memo Qualcomm Texas Instruments Broadcom 100% 25% 36% Market Cap 55.84B 29.77B 17.23B Employees 16,100 26,584 7,769 Revenue (ttm) 10.78B 11.55B 4.88B EBITDA (ttm) 4.08B 3.96B M Trailing P/E (ttm) Forward P/E Gross Margin (ttm) 69.27% 50.94% 49.57% Operating Margin (ttm) 31.71% 26.40% 4.98% Retrun on Equity (ttm) 16.68% 22.20% 9.51% Total Cash 11.16B 2.79B 2.04B Total Debt No Debt No Debt No Debt Current Ratio Beta Short as % of Float 1.40% 2.10% 3.80%

10 Appendix 13: Discounted Cash Flow (DCF) Analysis with Basic Sensitivity Analysis Company Name Qualcomm, Inc. Last Fiscal Year End 12/31/2009 Discounted Cash Flow Analysis for Qualcomm, Inc. Numbers in millions, except per share Historical Projected CAGR Revenues: Equipment and Services $ 5,765.0 $ 7,160.0 $ 6,466.0 $ 6,679.4 $ 7,380.7 $ 8,450.9 $ 9,803.1 $ 11,273.5 Licensing and Royalty Fees 3, , , , , , , ,241.7 x Total Revenues 8, , , , , , , , % Cost of Goods Sold 2, , , , , , , ,641.1 Gross Profit 6, , , , , , , , % Selling, General & Administrative 1, , , , , ,555.3 Research & Development 1, , , , , , , ,337.3 EBITDA 3, , , , , , , , % Less: Depreciation (383.0) (456.0) (635.0) (589.1) (661.4) (769.9) (910.6) (1,067.8) EBIT 2, , , , , , , , % Less: 23.3% (671.7) (869.1) (754.7) (798.0) (885.0) (1,017.6) (1,189.2) (1,377.9) x Tax-effected EBIT 2, , , , , , , ,535.9 Plus: Depreciation & Amortization ,067.8 Less: Capital Expenditures (818.0) (1,397.0) (761.0) (785.5) (870.3) (999.8) (1,167.5) (1,351.6) + / ( - ): Changes in Working Capital (345.0) 3,460.0 (4,333.0) (903.8) (1,001.5) (1,150.5) (1,343.4) (1,555.3) x Unlevered Free Cash Flow $ 2,121.3 $ (1,540.1) $ 6,691.3 $ 3,334.5 $ 3,705.9 $ 4,270.2 $ 5,001.1 $ 5,807.3 Historical Projected Value Drivers Equipment and Services Growth 24.2% (9.7%) 3.3% 10.5% 14.5% 16.0% 15.0% Licensing and Royalty Fees Growth 28.2% (0.8%) 3.3% 11.3% 15.5% 18.0% 17.0% Total Revenues Growth 25.6% (6.5%) 3.3% 10.8% 14.9% 16.8% 15.8% Cost of Goods Sold (as a % sales) 30.2% 30.6% 30.5% 30.5% 30.5% 30.5% 30.5% 30.5% SG&A (as a % sales) 12.3% 11.3% 8.8% 8.8% 8.7% 8.6% 8.5% 8.4% R&D (as a % sales) 20.6% 20.5% 23.4% 23.4% 23.4% 23.4% 23.4% 23.4% Depreciation (as a % CapEx) 46.8% 32.6% 83.4% 75.0% 76.0% 77.0% 78.0% 79.0% EBITDA Margin 36.8% 37.6% 37.2% 37.3% 37.4% 37.5% 37.6% 37.7% CapEx (as a % sales) 9.2% 12.5% 7.3% 7.3% 7.3% 7.3% 7.3% 7.3% Changes in Working Capital (as a % of Sales) (3.9%) 31.1% (41.6%) (8.4%) (8.4%) (8.4%) (8.4%) (8.4%) Weighted Average Cost of Capital 9.50% Sensitivity Analysis (Equity Value Per Share) Terminal Year Growth Rate 3.30% Equipment and Services Sales Growth $ % 3.3% 6.6% 9.9% NPV of Unlevered Free Cash Flow $ 16, % $ $ $ $ Terminal Year Unlevered FCF 96, % $ $ $ $ PV of Terminal Free Cash Flow 61, % $ $ $ $ Enterprise Value $ 78,018.8 Royalty 2.5% $ $ $ $ Less: Debt 0.0 Revenues 3.3% $ $ $ $ Add: Cash 2,717.0 Growth 4.1% $ $ $ $ Equity Value $ 80, % $ $ $ $ % $ $ $ $ Diluted Shares: 1, % $ $ $ $ x Equity Value Per Share $ Margin of Safety 45%