Qualcomm

Qualcomm is the leading manufacturer of wireless chipsets that are used in mobile devices and in wireless networks (smartphones, tablets, modems, etc). The more these devices are sold, the more Qualcomm earns. 

This sounds simple. But, if you read its typical business description, like the one posted below (copied from Google Finance), you’ll likely be lost in what they do, especially in trying to understand the jargons. 

“QUALCOMM Incorporated is engaged in the development and commercialization of a digital communication technology called code division multiple access (CDMA). The Company is engaged in the development and commercialization of the orthogonal frequency division multiple access (OFDMA) family of technologies, including long-term evolution (LTE), which is an Orthogonal Frequency Division Multiplexing (OFDM)-based standard that uses OFDMA and single-carrier Frequency Division Multiple Access (FDMA), for cellular wireless communication applications. The Company’s segments include QCT (Qualcomm CDMA Technologies), QTL (Qualcomm Technology Licensing) and QSI (Qualcomm Strategic Initiatives). The Company also develops and commercializes a range of other technologies used in handsets and tablets that contribute to end user demand. The Company’s products principally consist of integrated circuits (chips or chipsets) and system software used in mobile devices and in wireless networks.” 

Ok, ignoring all the jargons, let’s just look directly at the main revenue drivers:
Revenue breakdown - 2015.png
Source: Qualcomm’s FY15 10K

 

Equipment and services business (QCT) contributes 67-70% of revenue. This business develops integrated circuits and system software for use in wireless and wired devices, such as mobile phones, tablets, laptops, routers, desktop computers, etc. It holds around two-third of the smartphone chip market.

Licensing business (QTL) contributes the remaining 30-33% of revenue. It grants licenses to use portions of its intellectual property (IP) portfolio, such as certain patent rights in the manufacture and sale of wireless products, e.g. smartphones and tablets. It owns the IP for 3G/4G technologies that are used in smartphones. 

QCT has more than double the revenue of QTL, but it’s the latter that is highly profitable. QTL contributes around 63 – 73% of operating profit over the past 3 years. QTL earns license fees and royalties from the sales of devices that use its technologies. This is the business that captures my attention.

Segment profit - 2015.png
Source: Qualcomm’s FY15 10K

 

We can write several pages of reports to discuss about Qualcomm’s business, its competitive advantage, the risks it faces, the competitors, the trend, outlook and so on. This will be too complicated for general public, so, I will just mention few key points.

Right Business
Basically, Qualcomm is a very good and innovative technology company. It’s highly profitable and has been expanding its business very well. The financial performance over the past 10 years clearly demonstrated that. It also has high ROA and ROE (relative to its industry) with a very strong balance sheet, holding net cash of $19 billions (compared to book value of $30 bn and current market cap of $97 bn). It has favorable long-term prospects with more and more people using smartphones and other wireless devices in future. Its licensing business, protected by patents, provide a very strong recurring income.
Financials 10Y - FY15.PNG
Profitability 10Y - FY15.PNG
Source: Morningstar.com
Right Management
The current Management has been in place since more than a decade ago. Many of the senior executives joined Qualcomm in 1990s and early 2000s and were promoted within the firm to their current positions. It is this present Management that tripled Qualcomm’s revenue and doubled its net income over the past 10 years. The Management is also committed to buying back its own shares and has been doing that for many years. Since 2003, they have returned $53.1 billions to the shareholders in terms of dividends and share buy-back.
Cumulative return to shareholders - FY16Q3.PNG
Source: Qualcomm’s FY16 Q3 Presentation 

Right Price
In the past three years, it has generated total FCF of $19.9bn. It has the potential to maintain and even increase the revenue and FCF for next several years. With conservative estimated FCF of $5.5bn per year and assuming discount rate of 9.5% and growth rate of only 3.0%, the estimated enterprise value is 84.6bn. Adding net cash of 19bn, the estimated equity value is 103.6bn or $70 per share

The estimated FCF, discount rate and terminal growth rate are subjective. A small change in any of them can have substantial impact on the estimated value. I think my assumptions have been reasonably conservative. 

The share price reached the peak of $80 per share in mid 2014. The TTM P/E at that time was around 19-20x. Around that time, the Company reported lower than expected outlook and was expected to be fined by China’s antitrust regulator, which had confirmed earlier that Qualcomm had monopoly.  The share price fell all the way to $44 in Feburary 2016. That’s 45% dropped! The revenue and net profit did fall during this period, but it’s the drop in the market expectation that wiped out most of the market value. 

My friend told me about Qualcomm business in September 2015. After some study, I bought it at $56.49 on 7 October 2015. When I bought it, I estimated its value to be around 95bn, including net cash of 24bn at that time. That’s $65 per share. When the market turned bearish on Qualcomm, the price fell to $56 per share or market cap of 83bn. I thought I had 14% margin of safety. Four months after I bought it, it fell to the bottom at $44, incurring paper loss of 22%. After that, it bounced back to $63. It announced the acquisition of NXP Semiconductors last week, and the share price spiked to $67. 

Today is nearly 1 year of buying Qualcomm. At entry price of 56.49, current price of 67 and dividend of 1.49 collected, the return is 21% in one year in USD term.

But, when I bought it, the USD-SGD was 1.42 and this rate has fallen to 1.37 now. The dividend I received was taxed at 30%. So, after adjusting for forex + taxes + trading fees, my return in SGD is 14%. Not fantastic, but I’m happy with it.

 

Qualcomm is a mega-cap and well followed by many analysts and funds. Do not expect that you can out-analyze the army of many smart analysts and fund managers out there. You are not likely to have a special insight in Qualcomm’s business that is not already known by the market. In other words, Qualcomm’s share price is quite efficient most of the time.

However, occasionally, the market can be overly optimistic or pessimistic. This happens from time to time. It was probably overly optimistic in 2014 and overly pessimistic in late 2015. If you do your valuation conservatively, you can wait patiently for market mispricing to occur and take advantage of it. 

 

In my valuation, I have factored in growth of only 3.0%, despite the fact that Qualcomm managed to grow its revenue at CAGR of 18% and net income at CAGR of 10% over the past 5 years. I think I was too conservative in my valuation. But even with such conservative valuation, the share price gave nearly 15% margin of safety at that time. That allowed me to buy the shares with low risk.

Growth10Y - FY15.PNG
Source: Morningstar.com

 

Going forward, I think Qualcomm still has good growth potential, but is also facing some challenges from the competition. Margins in smartphone business are getting lower, so the smartphone makers are likely to negotiate with Qualcomm for lower licensing and royalty fees. The fine by Chinese government is a big warning to watch its pricing if it wants to do business in China. 

I don’t have special insight into how well it can perform in future. Given its historical performance and management competence, it’s likely to continue to do well. Qualcomm is also investing in Internet of Things (IoT), which could potentially be the next BIG thing. But at current price, I think Qualcomm is quite fairly priced. The market expectation has gone up again and Qualcomm will have to meet the high expectation or exceed the expectation in order to have its share price appreciate more than the general market. I also don’t have any insight in how IoT will perform in future.

 

Its acquisition of NXP Semiconductors also changed its overall value now. The deal is worth $30bn, or around 30% of Qualcomm’s value. NXP is a high growth company but is also highly priced at P/E of 25-30x at the moment. It has met and exceeded expectation so far, and its share price rose 540% since its IPO in 2010. I don’t know anything about NXP’s business and whether the deal is at fair price. Looking at the market response, the deal seems positive to Qualcomm and the market is expecting some synergy to be created. Hope the market is right.

NXP - share price - 2016-10-04.PNG

I’m selling my position in Qualcomm. The reason I bought it was because it’s undervalued at that time. Its acquisition of NXP is significant and I know nothing about NXP. Even without this acquisition, I think Qualcomm is fairly priced now.

Qualcomm - share price - 2016-10-04.PNG
Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s