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Company Description
Qualcomm is a semiconductor company which produces wireless communication chips for mobile devices. It belongs to the information technology sector and the telecommunications equipment subsector of S&P 500. The company has two major segments; one active in designing and developing of new devices and the other licensing of the developed products. Thus, more than 77% of the firm’s revenue is from loyalties of the licensed patents. Unlike many other semiconductor companies, such as Intel, Qualcomm does not have production facilities, so called fabs, and therefore is dependent on the third parties for manufacturing of its developed devices.
Investment Thesis
Based upon my macroeconomic analysis, IT sector has a promising short term and mid-term performance in the stock market. Qualcomm has had a healthy revenue growth of 30% to 40% which is anticipated to be 5-10% in the next two years. The company has consistently maintained its dominance in the market. My evaluation reveals a total return of above 9% by owning the stock. Qualcomm’s stock is also undervalued compared with the sector and S&P 500 index. Therefore, I recommend BUY for this stock.
Recommendation Risks
Although my recommendation is BUY for this stock, I also foresee risks associated with the company’s future earnings and therefore its stock performance. Legal challenges remain a major source of concern for the company. In January 2015, the firm paid close to $1Bn fine to the Chinese government for business irregularities. There are, however, other legal suits in China, South Korea and Europe that the company may face in near future. In addition, since the firm has no production facility, it is mainly dependent on the revenues generated by its R&D activities. A significant portion of the revenue is sourced to 2-3 customers. Any changes in the competitive landscape affecting the customers will significantly hamper revenue generation for the firm.
Recommendation: Buy
Qualcomm Inc.
Date: 4 April 2015
Current Price: $67.97
Target Price: $72.37
Total Return: 9.29%
Ticker: QCOM
Market Cap.: $112.12Bn
Dividend Yield: 2.82%
Shares Outstanding: 1.65Bn
52-Week Price Range: $81.60- $62.46
Trailing P/E= 14.36
Forward P/E= 12.52
P/Book= 2.96
P/Sales= 4.25
ONE YEAR PRICE
Analyst: Mehdi Mirsaneh, [email protected] 4 April 2015
Table of Contents
COMPANY OVERVIEW ....................................................................................................................... 3
Business Segments ........................................................................................................................ 3
Competitive Landscape and Current Challenges .......................................................................... 4
Qualcomm’s Sustained Competitive Advantage .......................................................................... 5
Recent Important News and Events ............................................................................................. 5
INVESTMENT THESES ....................................................................................................................... 6
Economic Analysis ........................................................................................................................ 6
Key Industrial Drivers ................................................................................................................... 7
Financial Analysis and DCF Model ............................................................................................... 8
Valuation Analysis ....................................................................................................................... 11
RISKS ................................................................................................................................................. 14
SUMMARY AND CONCLUDING REMARKS ................................................................................... 15
BIBLIOGRAPHY ................................................................................................................................ 16
APPENDIX 1: INCOME STATEMENT FORECAST- PART 1 ............................................................ 17
APPENDIX 2: INCOME STATEMENT FORECAST-PART 2 ............................................................ 18
APPENDIX 3: DCF MODEL .............................................................................................................. 19
APPENDIX 4: SENSITIVITY ANALYSIS OF VALUATION ............................................................. 20
Mehdi Mirsaneh
COMPANY OVERVIEW
Qualcomm is a semiconductor firm active in
the design and development of chip-based
devices for wireless applications. Formed in
1985 by seven industry veterans, Qualcomm
Communications landed its first contract in the
same year with the US army to work on secure
communications. In 1988, Qualcomm
launched a satellite tracking system to track
truck fleets for transportation industry. In the
following years, Qualcomm established itself in
the wireless communication systems by
developing new multi-transmitter systems
which use a single channel for wireless
communications, creating a path for the
application of GPS technology for commercial
use. In 1991, Qualcomm became a public
company by conducting its IPO on NASDAQ.
During the past 24 years, Qualcomm’s main
business activity had been in the research and
development of variety chipset designs, chiefly
for wireless communications. Its designs have
been employed by the main wireless
communication device manufacturers,
including Samsung and Apple to incorporate
variety of communication technologies,
including GPS, Voice, WiFi, Bluetooth etc., in
smart phones. In simple terms, Qualcomm’s
designs are applied using semiconductor
manufacturing processes in fabrication plants
(also called fabs or foundries). However,
Qualcomm is a fabless firm; that is, it has no
fabrication plants. Thus, the main activity of
Qualcomm is the research and development of
new designs, followed by licensing them to
third parties that own fabrication plants. This
business model has some advantages and
disadvantages which will be addressed in the
following sections.
Business Segments
Qualcomm business is mainly composed of two
major units:
1- Qualcomm CDMA Technologies (QCT),
which owns the R&D, products and services
including the semiconductor services, and
covers all product development activities.
2- Qualcomm Licensing business (QTL), which
owns the majority of the company’s patent
portfolio, and covers all licensing activities of
the company.
QCT is the backbone of the business. In fact,
the income from QTL does not materialize
without the products developed at the QCT
business. QTL licenses the technologies which
are developed by the QCT. QCT also directly
involves in production and sales in cooperation
with partners (as explained in the previous
section) and has a larger value of sales
compared with QTL, see below graphs.
However, the largest earning is attributed to
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the QTL, since the segment’s activities are only
licensing which incur almost no costs.
Competitive Landscape and Current Challenges
The huge increase in the usage of mobile
devices including cell phones and tablets has
been the main driver of growth for
semiconductor industry. As shown in the below
graphs, in 2012, mobile devices accounted for
62% of the total semiconductor market. While
the total market for semiconductor industry is
expected to grow to $380Bn, wireless
communication applications are anticipated to
have the largest growth (~11%), accounting for
32% of the market (~$120Bn) [1].
However, there are challenges facing the firms
within the industry including Qualcomm. The
foundries, or fabs, are extremely expensive
(around $4Bn) to build and have high fixed
costs. Therefore, only firms with a huge market
can set up and run the facilities. Alternatively,
there are firms which only manufacture
(mainly located in Taiwan and China) devices,
licensing designs from fabless firms such as
Qualcomm. Intel, the giant semiconductor
manufacturer, and Samsung are the rare firms
which are vertically integrated into design and
have foundries. The consolidation of
Sales
Earnings
Comp Annual Growth Rate
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manufacturing within few fab-based firms and
the mobile device customers in mainly two
firms (Apple and Samsung) have created
limited maneuver space for fabless firms.
Therefore, companies such as Qualcomm are
facing the challenge of competition to sell
designs to Apple and Samsung and at the same
time encountering little bargaining power over
foundries, reducing their profit margin
significantly. Moreover, R&D activities are
generally associated with high initial costs. The
risk for a firm like Qualcomm, therefore, is that
the developed designs fail to grasp the
attention of the big players/customers (Apple
and Samsung) in the field, resulting in a huge
sunk cost for the company. Moreover, the
company is facing antitrust government
investigation which could cost the enterprise
billions of dollars. This challenge will be
addressed in more detail in the “Recent
Important News and Events” section.
Qualcomm’s Sustained Competitive Advantage [2]
As previously mentioned, there are challenges
facing a fabless firm like Qualcomm, but it is
vital to note that Qualcomm has some
competitive advantages which seem to sustain
for foreseeable future. Qualcomm’s main
advantage is its vast portfolio of intellectual
property which covers the multi-channel
communications (transmitting variety of data
including voice, video and text over the same
band, also described as 3G/4G technologies).
Qualcomm currently collects $7 loyalty fee
from each smart phone sold globally and this
will soon grow dramatically. Presently, only
20% of all cell phones sold globally are smart
phones (work on 3G/$G technologies). This
figure is expected to grow fast within the next
few years, creating almost one way profit
generating path for Qualcomm. In addition,
Qualcomm intelligently has used this
advantage to form a monopoly in the market as
its all other designs are integrated into the
original platform which is covered by its
intellectual property, making the customers
dependent on Qualcomm wireless devices.
Therefore, it appears that a mixture of
intellectual property and design integration
along with huge investment in R&D are
Qualcomm’s competitive advantages which are
anticipated to be sustainable for years to come.
Recent Important News and Events
The most important news has been settling the
Chines antitrust government investigation in
the early days of January 2015. Qualcomm was
under investigation for the market monopoly
in China as a result of competitors’ protest.
Following few months of investigation,
Qualcomm eventually settled the dispute by
paying close to $1Bn fine to the Chinese
government. Although this was positive news,
it appeared that the antitrust woes are far from
over, as the South Korean government also
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announced that it was looking in a similar
pattern of activities in Korea. This was in
addition to other news that the US and
European governments had also initiated
similar investigations [3]. Although, none of
the other investigations have shown any sign of
misconduct, the presence of such negative
news around the firm affects the performance
of Qualcomm stocks in the market.
INVESTMENT THESES
Economic Analysis
The technology sector has a cyclical pattern
which closely follows the overall economic
trend of the country. Since many companies in
the IT sector manufacture consumer products,
it is possible to predict the earning trend in the
sector by evaluating the consumer spending
pattern. Figure below [4] reveals the personal
savings and household net worth
simultaneously, revealing that the personal
savings increases (or spending decreases) when
the household net worth increases. There are
many factors affecting household net worth,
including employment, household expectation
of future income growth, housing prices etc.
Looking at the net worth trend and the
aforementioned parameters which are affecting
it, I anticipate that the consumer spending
increases within the next 12 to 18 months. As
the sector’s earning grows, the stock will have a
positive performance, as expected. Thus, I
expect that the IT sector will have a promising
near term stock performance.
Following the 2008 financial crisis, we
observed government interference to limit the
crisis using different strategies including
decreasing the interest rate to almost zero%.
However, it is expected that the Fed will soon
increase interest rates. Table below [5] shows
the expected effect of interest rise on different
sectors, indicating that the technology sector is
predicted to have the highest positive
performance as a result of the interest rate rise.
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Since Qualcomm is a member of the
Communications Equipment subsector of the
IT sector, it is also important to assess the
performance of this subsector against the IT
sector and the S&P 500, below figure. It is
evident that the subsector’s performance has
been consistently underperformed the sector,
indicating that the performance gap between
the sector and subsector may increase in near
future (sign of further underperformance).
Key Industrial Drivers
Smart Phone Usage
As explained above, one of the major
applications of Qualcomm’s products is in
multi-channel communication of voice and
data simultaneously, in particular in portable
devices such as smart phones, Tablets etc.
Thus, it is apparent that the usage of smart
portable devices and their production and sales
would be the main driver for the Qualcomm’s
revenues. Below graphs show various smart
device usage forecast till 2016 for different
applications and regions, indicating a
significant growth, especially in smart phones
and in Asia-Pacific [6]. Therefore, it is
anticipated a steady market growth for
Qualcomm’s CDMA based platform products
which support data –voice -video
communications used in the aforementioned
devices.
3G/4G
Third and fourth generation (3G & 4G) cell
phones have been a key driver of the growth in
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the usage of smart phones. As of 2014, there
have been 2.8Bn devices based on these
technologies which are expected to grow to 5Bn
by 2018. Presently, the CDMA design is the
superior product in the market and has the
largest market share. Therefore, providing
CDMA remains the best choice in the market,
Qualcomm’s revenue is expected to grow.
Internet of Things
The Internet of Things is a concept in which
different smart devices are connected with
each other through internet, creating a new
market for wireless connecting devices.
Qualcomm’s designs and products have put the
firm in a strategic position to take advantage of
this huge market which is expected to reach
~$41Bn by 2020 [7], see below graph. It
appears that Qualcomm has already taken the
steps to dominate this market by developing
new wireless communication devices for
healthcare and auto industry [8].
Other Players
Another key driver for Qualcomm’s revenue is
the fact that whether its products remain the
customers’ choice of design in future. Recently,
Intel has started to develop similar products
which could significantly challenge
Qualcomm’s sales in future. Samsung, itself a
device designer, may introduce new products
which can outclass Qualcomm designs, leading
to the loss of product dominance by company.
Financial Analysis and DCF Model
Revenues
As shown in Appendix 1 also in below table, my
revenue projection is in line with the analysts’
consensus. Looking at the historical revenues
below graph, apart from 2011 to 2013 when
there was a large increase in the growth rate
(likely due to the after-recession effect), the
growth had been between 5-6%. Therefore, I
chose a 5.5% growth rate and decreased it to
4~% to highlight the fact that the growth will
most likely approaches to the nominal GDP
growth of 4% in coming years. While the
growth between 2011 and 2013 was 30% - 40%,
it is vital to note that it is unlikely that the firm
could realize such a large revenue growth
within the next few years.
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Revenue My Projection Analysts’ Consensus
2015 $27,948m $27,194m
2016 $29,503m $28,476m
As noted in the SEC fillings of the firm [9],
there are two main segments which are the
source of revenue generation; i.e. equipment-
services and licensing. Equipment and services
is the larger source and expected to growth at a
larger pace compared with the licensing
section. In 2014, equipment and services
revenues, which were mostly related to sales of
MSM and accompanying RF and PM
integrated circuits, were $18.43Bn, forming
almost 99% of QCT segment revenue. The QTL
section, however, generated only $7.6Bn in
2014 and was mainly flat. The firm attributed
the low growth rate in this segment to the
under-reported royalty fees from licensees, in
particular in China where the huge legal battle
has undermined the firm operation. Indeed,
the positive impact of the legal resolution in
China on the revenue growth of this segment
needs to be seen. The fact that the growth in
revenue in the QTL segment has been flat is
alarming, since this segment contributes a
much larger profit margin to the firm’s income.
According to the firm fillings [9], China, South
Korea and China comprised 50%, 23% and 11%
of revenue generations, respectively, majority
of which through loyalties of licensed designs.
Although, Chinese market growth seems
promising, Qualcomm’s legal challenges in the
country may hamper its future growth; see the
risk section.
Gross Profit
Below figure shows my projection of gross
profit against the analysts’ consensus,
highlighting that my gross profit projection for
2015 and 2016 was slightly higher than the
analysts’.
Gross Profit My Projection Analysts’ Consensus
2015 $17,607m $15,950m
2016 $19,177m $17,061m
Although the main reason behind this
difference will be revealed when the relevant
costs are discussed, I would like to mention
one key point here. As stated above my revenue
projection was closely following the analysts’,
Revenue
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and therefore, the main reason behind the
difference should be associated with the costs
projection. This could be, alternatively, seen in
the gross profit margin as shown in the below
table, revealing a higher estimation of profit
margins in my projection, in contrast to the
analysts’.
Gross Profit Margin My Projection Analysts’ Consensus
2015 63.0% 58.7%
2016 65.0% 59.9%
As discussed previously, QTL segment has
higher profit margin and one may logically
contribute the differences to the QTL’s
projection. However, since the QTL has a
negligible cost, as it is only a licensing unit, I
believe the main differentiating source is the
projection of the QCT’s revenue.
Cost of Equipment and Services
The majority of the cost of equipment and
services is associated with the QCT business
unit, as the QTL has no significant costs, as
described before, due to its business activity
which is merely licensing of designs. According
to the SEC filing of the firm in 2014 [9], the
cost of equipment and services also includes
the cost of shipping and handling. Due to the
economic downturn in the rest of world and
low energy costs as well as labor costs, I
anticipate that the cost of equipment and
services remain flat, in contrast with the
consensus projection of growth for these costs,
below table.
Cost of Eq. & Services
My Projection Analysts’ Consensus
2015 $10,341m $11,243m
2016 $10,326m $11,415m
Research and Development
Rapid technological changes in the wireless
communication industry demands huge
investment in the research and development
for firms which intend to remain competitive
within the sector. Looking at the financial
statement of the firm, Qualcomm has increased
its investment in R&D significantly, ~83%
increase from 2011, signaling that it has
prepared itself for the fierce competition in
future. Thus, I predict that this investment will
result in higher revenues in the next 3 to 5
years. Increased investment in R&D helps
Qualcomm maintain its leadership position in
its flagship designs in the LTE baseband
market which the firm currently holds ~95% of
market share [7].
Selling, General and Administrative (SG&A) Costs
As revealed in the income statement of the
company, SG&A is the third largest cost,
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forming ~12% of the total costs. According to
the firm’s SEC filing, SG&A includes legal costs
(~2.6%), share-based compensation (2.3%)
and marketing and employee compensation
costs. During 2014, firm has encountered
higher employee and marketing expenses,
leading to higher SG&A costs. The $56m
increase in marketing expenses seems to be in
line with the firm’s attempt to maintain its
market share, a positive move which should
translate into higher revenues in future.
Earnings Per Share (EPS)
Based on my evaluation, I expect that the
firm’s EPS to grow at 7-9% annually in the next
two years, reaching $5.31. This is consistent
with some analysts’ forecast which indicated an
EPS of $5.44 in 2016 [10], below table.
Earnings Per Share
My Projection Analysts’ Consensus
2015 $4.96 $5.02
2016 $5.31 $5.44
However, some other analysts had a slightly
different projection, in particular for 2015 [11].
They forecast EPS of $3.5 to $4.75 for 2015,
which is smaller than my and Bloomberg
analysts’ expectations. This could be due to a
different projection of revenues for the coming
year, attributed to difficulties and risks in
China. However, as explained previously, this
risk has been almost eliminated by the new
legal settlement agreement which occurred at
the end of January 2015. On March 9 2015,
Qualcomm announced that it will repurchase
$10Bn of its stock and increase dividend by
about 14% in the next 12 months [12].
Improving the EPS (by reducing the number of
shares outstanding) and increasing the
dividend will positively affect the firms stock
price in near future.
Valuation Analysis
Valuation Based on Multiples
So far the valuation analysis was based on the
DCF model which aims to look at the intrinsic
value of stocks compared to the current market
price. In this section, I will look at Qualcomm’s
current market price and compare it with the
index (S&P 500), the information technology
sector and the competitors to assess how the
firm’s stock performing in the market.
Although, this assessment provides us with
useful information, the DCF is indeed the best
way to identify undervaluation.
Qualcomm vs S&P 500
Below graph reveals the Qualcomm’s share
price in the past 12 months, compared with
S&P 500 index, showing that the firm’s stock
has performed negatively compared with the
market. The following table compares
Qualcomm’s P/E, P/B, P/S and P/EBITDA
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relative to S&P 500, in the past 12 months. The
current P/E ratio is 0.79, indicating that it is
relatively smaller than the S&P 500. During the
past 12 months, however, P/E ratio of
Qualcomm compared with S&P 500 was
ranging from 0.61 to 1.19 with a median of
0.90. Thus, the data reveals that the current
P/E ratio of Qualcomm is lower than the
median within the past year. The P/B ratio,
relative to S&P 500, is indeed the lowest within
the past 12 months. Similarly, P/S ratio
compared with S&P 500 is now the lowest
within the past 12 months.
Looking merely at these ratios and market
share price compared to S&P 500, it appears to
me that Qualcomm’s shares are currently
undervalued. However, it is key to note that the
more important comparison is between
Qualcomm and the sector and peers, the
upcoming sections, which will reveal more
accurately how the stock has been performing.
QCOM vs S&P 500 High Low Median Current
P/E 1.19 0.61 0.90 0.79
P/B 1.77 1.04 1.21 1.04
P/S 5.41 3.21 3.28 3.21
Qualcomm vs Information Technology Sector
In comparison to the IT sector, Qualcomm’s
P/E ratio is lower than 1 and is lower than the
median during the past 12 months, see below
table. Similarly, the P/B ratio vs the sector is
now the lowest within the last year. In contrast,
P/S seems to be relatively always higher than
one, although this ratio was the lowest
compared to the sector within the last 12
months. Therefore, in summary, it appears that
Qualcomm’s stock ratios vs the sector is either
at the lowest or close to lowest, indicating that
Qualcomm’s stock is undervalued.
QCOM vs IT Sector High Low Median Current
P/E 1.27 0.50 0.77 0.73
P/B 1.10 0.69 0.80 0.69
P/S 3.76 1.34 1.89 1.34
S&P 500
Qualcomm
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Qualcomm vs Peers
Relatively to its peers, Qualcomm’s ratios are
shown in the below table. The peers have been
chosen based on the products and the market
and how close is their business to Qualcomm.
These firms are either manufacturing
competing products or are semiconductor
firms that do not possess foundry (they are
fabless), similar to Qualcomm.
Apart from Micron Technology which has a
P/E ratio of 9.58, Qualcomm’s P/E ratio is
almost the lowest compared to peers. The P/B
ratio seems to be slightly different as
Qualcomm’s ratio is slightly higher than the
average of peers’ P/B ratios (3.00). The
average P/S ratio of peers is 3.55, which is
lower than Qualcomm’s. P/CF seems to follow
the same story line, as the average (15.17) is
lower than Qualcomm’s (15.95).
In summary, it seems to me that, apart from
the P/E ratio, Qualcomm’s other ratios are
higher than the peers, indicating that
Qualcomm’s stock price is overvalued in the
market relative to its peers.
Multiples Evaluation Price Target
Based on my assessment of Qualcomm’s
multiples versus the comparable firms, sector
and market, I identified my target multiples
each of which lead to different target prices. As
shown in the below table, the average of the
target prices is 14.9% higher than the current
market price for Qualcomm’s stock, indicating
that overall Qualcomm’s stock is presently
undervalued, a similar conclusion to DCF
valuation model.
Abs Valuation Current
My Target
Multiple
Target /Current
Exp. EPS Target
Price
P/E 15.73 20 1.27 $4.5 $90
P/B 3.09 3.5 1.13 N/A $81.6
P/S 4.6 4 0.87 N/A $62.8
P/EBITDA 13.83 15 1.09 N/A $78.7
Average $78.1
Upside/ Downside Potential Over Current Stock Price ($67.97) 14.90%
P/E P/B P/S P/CF
Qualcomm 15.73 3.09 4.60 15.95
Broadcom Corp. 31.0 2.98 2.9 17.40
Texas Instrument 20.6 4.54 5.6 17.11
Intel Corp. 15.58 3.06 3 16.37
Marvell Technology 17.41 2.11 ---- 12.70
NVIDIA Corp 19.55 2.45 2.7 16.37
Maxim Integrated 27.42 3.92 4.3 15.12
Micron Technology 9.58 1.98 2.8 11.14
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RISKS
Owning Qualcomm’s stocks similar to any
other stock is associated with risks. The risks
which are affecting the firm’s revenue would
affect its stock price too. It is therefore
important to evaluate the risks that
Qualcomm’s facing and how these risks could
impact its revenues in the coming years.
Narrow Range of Products
Qualcomm has limited number of very
successful products including CDMA and
OFDMA. The company’s revenue is therefore
dependent on the fact that these designs are
deployed by the customers and that the
customers develop other devices based on
these designs. The CDMA design accounts for
around 45% of Qualcomm’s revenue [13].
However, the firm has consistently lost the
market share to the competitors in the past ten
years. The market share which was once
around 81% reduced to ~60% in 2010 and
reduced further in the following years.
A main risk for Qualcomm is that the wireless
carriers and/or customers use other competing
technologies in future, instead. This will most
likely completely wipe out a major source of
revenue for the firm with disastrous
consequences.
Moreover, the future cash flow projection of
Qualcomm depends on the future adaptation of
3G/4G technologies in the developing markets.
Any delay in this trend could also significantly
affect Qualcomm’s future cash flows. The
expansion in the 3G/4G networks is dependent
on governments’ regulations. However, it is
known that governments’ actions are generally
associated with unpredictable delays, making
future employment of Qualcomm’s
technologies even less certain.
Limited Number of Customers
Qualcomm’s customers are mainly major
portable wireless device manufacturers
including Samsung and Apple. Samsung alone
accounts for ~20% of Qualcomm’s revenue.
However, Samsung itself is a designer and
manufacturer of wireless devices which may, at
any point, decide to develop its own products,
instead of paying royalties to Qualcomm.
Recently, January 2015, Samsung announced
that it may not deploy Qualcomm’s
Snapdragon 810 product in its Galaxy S6 smart
phones due to some technical issues.
During the company’s quarterly earnings
report on 28 Jan 2015, Qualcomm’s CEO, Steve
Mallengkopf, stated that “we now expect that
our Snapdragon 810 processor will not be in
the upcoming design cycle of a large customer’s
flagship device, impacting our outlook for both
volume and content in that device”. Qualcomm
owns around 94% of market share in LTE
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devices via its flagship product series of
Snapdragon.
Moreover, Intel, another Qualcomm’s major
customer and competitor may develop devices
and designs which outclass the firm’s products,
making them instantly obsolete. In fact, it was
announced that Intel would partially replace its
design in Apple’s IPhone products in 2016 [14].
The release of this single information on 11
March 2015 by an unknown source resulted in
2.25% drop in Qualcomm’s market share price,
while Intel gained around 2%.
Legal Challenges
Recently Qualcomm was engaged in a legal
battle in China due to an investigation by the
Chinese government’s antitrust agencies which
found illegal activities by Qualcomm. China is
almost the largest market for the firm. Even
the announcement of the investigation affected
Qualcomm’s earning as some of the firm’s
clients stopped paying their royalties for the
licensed designs. Thus, a negative legal
outcome could affect the firm’s future cash
flows significantly. However, the good news
was that Qualcomm could settle the dispute in
January 2015 by paying ~1Bn fine to the
Chinese government as well as agreeing a
change in its business model in the country.
However, it appears that the legal issues in
China are far from over. In March 2015, a
Chinese firm sued Qualcomm for trademark
infringes, asking for $100Bn of compensation.
Following the antitrust settlement in China,
South Korean and EU authorities also
announced that they had initiated an
investigation into Qualcomm’s activities in
their countries. If it is found guilty by the EU,
Qualcomm may be fined up to 10% of its global
revenues.
SUMMARY AND CONCLUDING REMARKS
Based on my analysis which is reviewed in this
document, I believe that the IT sector will have
an above average performance in the stock
market in near future. In particular, the return
of the sector will be higher if there is interest
rate rise by the Fed. However, the
Communications Equipment sub-sector might
have a weaker performance than the average of
the sector. My assessment reveals that
Qualcomm’s stock is slightly undervalued,
according to the DCF model (6.48%) and
multiples valuation (14.9%). There are,
however, risks associated with stock
recommendation. The firm’s future revenue
growth is highly dependent on many factors
which are not under the control of the
company. These include but not limited to the
narrow customer base, legal and antitrust
issues in Asia and Europe, low profit margin
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and the competitive nature of the industry.
However I believe the return outweighs the
risks, and therefore, I recommend BUY for
Qualcomm’s stock.
BIBLIOGRAPHY
[1] McKinsey&Company, "McKinsey on Semiconductors," McKinsey Practice Publications, 2013.
[2] V. Katsenelson, "Qualcomm's Competitive Advantage Are Too Numerous to Ignore," Institutional Investor, 25 11 2013. [Online]. Available: http://www.institutionalinvestor.com/blogarticle/3282549/blog/qualcomms-competitive-advantages-are-too-numerous-to-ignore.html#.VSLAJ_nF-h1. [Accessed 2015 04 04].
[3] C. Neiger, "Qualcomm's Antitrust Woes Are Far From Over," 19 02 2015. [Online]. Available: http://www.fool.com/investing/general/2015/02/19/qualcomms-antitrust-woes-are-far-from-over-but-inv.aspx. [Accessed 04 04 2015].
[4] D. Roberts, Economic Outlook, 2015. [5] N. Bohnsack, Quantitative Research &
Global Asset Allocation, 2015. [6] "The Blog," 04 06 2012. [Online].
Available: http://zeendo.com/info/mobile-growth-forecast/. [Accessed 04 04 2015].
[7] P. Sikka, "Market Realist," 19 11 2014. [Online]. Available: http://marketrealist.com/2014/11/qualcomm-plans-tap-internet-things-market-growth/. [Accessed 04 04 2015].
[8] Compnay Website, "Qualcomm," [Online]. Available: https://www.qualcomm.com/. [Accessed 04 04 2015].
[9] SEC 2014 Filings, "SEC," 2014. [Online]. Available: http://www.sec.gov/Archives/edgar/data/804328/000123445214000320/qcom10-k2014.htm. [Accessed 04 04 2015].
[10] Bloomberg, [Online]. [Accessed 2015]. [11] 4-traders, "Qualcomm," [Online].
Available: http://www.4-traders.com/QUALCOMM-INC-4897/?type_recherche=rapide&mots=qcom. [Accessed 04 04 2015].
[12] L. Gensler, "Qualcomm Plans $15B Stock Buyback, Hikes Dividend," Forbes, 09 03 2015. [Online]. Available: http://www.forbes.com/sites/laurengensler/2015/03/09/qualcomm-plans-15b-stock-buyback-hikes-dividend/. [Accessed 04 04 2015].
[13] Forbes Magazine, "Qualcomm Cruises To $53 If It Slows Bleeding In CDMA Market Share," Forbes, 20 10 2010. [Online]. Available: http://www.forbes.com/sites/greatspeculations/2010/10/20/qualcomm-cruises-to-53-if-it-slows-bleeding-in-cdma-market-share/. [Accessed 04 04 2015].
[14] M. Perrault, "Intel, Not Qualcomm, Modem Chips For iPhones: Report," Investor.com, 11 03 2015. [Online]. Available: http://news.investors.com/technology/031115-743065-intel-modem-chips-reportedly-might-go-into-iphones.htm. [Accessed 04 04 2015].
Stock: Qualcomm Inc.
Ticker: QCOM
Current Price: $67.97
Target Price: $72.37
Recommendation: buy
Analyst: Mehdi Mirsaneh
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APPENDIX 1: INCOME STATEMENT FORECAST- PART 1
Consensus- Revenue 29,909$ 28,470$ 27,100$ 2017E 2016E 2015E 2014 2013 2012 2011 2010
Revenues:Equipment and Services 22,390$ 21,324$ 19,929$ 18,625$ 16,988$ 12,465$ 9,223$ 6,971$ Licensing 8,261$ 8,180$ 8,019$ 7,862$ 7,878$ 6,656$ 5,734$ 4,011$
Total Revenue 30,651$ 29,503$ 27,948$ 26,487$ 24,866$ 19,121$ 14,957$ 10,982$ Costs and expenses:
Cost of equimpent and services revenues 10,728$ 10,326$ 10,341$ 10,686$ 9,820$ 7,096$ 4,877$ 3,301$ Research and development 6,130$ 5,901$ 5,590$ 5,477$ 4,967$ 3,915$ 2,995$ 2,451$ Selling, general and adminstrative 2,759$ 2,655$ 2,515$ 2,290$ 2,518$ 2,270$ 1,945$ 1,503$ Other 552$ 531$ 503$ 484$ 331$ 158$ 114$ -$
Total costs and expenses 20,169$ 19,413$ 18,949$ 18,937$ 17,636$ 13,439$ 9,931$ 7,255$ Operating income 10,483$ 10,090$ 8,999$ 7,550$ 7,230$ 5,682$ 5,026$ 3,727$ Investment income, net 1,379$ 1,328$ 1,258$ 1,228$ 964$ 880$ 661$ 766$
Income from continuing operations before income tax 11,862$ 11,418$ 10,257$ 8,778$ 8,194$ 6,562$ 5,687$ 4,493$ Income tax expense (1,779)$ (2,055)$ (1,539)$ (1,244)$ (1,349)$ (1,279)$ (1,132)$ (973)$
Income from continuing operations 10,083$ 9,363$ 8,718$ 7,534$ 6,845$ 5,283$ 4,555$ 3,520$ Discontinued operations, net of income taxes -$ -$ -$ 430$ -$ 776$ (313)$ (273)$
Net income 10,083$ 9,363$ 8,718$ 7,964$ 6,845$ 6,059$ 4,242$ 3,247$ Net loss attributable to noncontrolling interests -$ -$ -$ 3$ 8$ 50$ 18$ -$
Net income attributable to Qualcomm 10,083$ 9,363$ 8,718$ 7,967$ 6,853$ 6,109$ 4,260$ 3,247$
Basic earning per share attributable to Qualcomm:Continuing operations 4.48$ 3.99$ 3.14$ 2.76$ 2.15$ Discontinoued operations 0.25$ -$ 0.45$ (0.19)$ (0.17)$ Net income 4.73$ 3.99$ 3.59$ 2.57$ 1.98$
Diluted earnings per share attributable to Qualcomm:Continuing operations 4.40$ 3.91$ 3.06$ 2.70$ 2.12$ Discontinoued operations 0.25$ -$ 0.45$ (0.18)$ (0.16)$ Net income per share (EPS) 5.88$ 5.46$ 5.09$ 4.65$ 3.91$ 3.51$ 2.52$ 1.96$ Consensus EPS 5.68$ 5.31$ 4.96$
Shares used in per share calculations:Basic 1,683 1,715 1,700 1,658 1,643 Diluted 1,714 1,714 1,714 1,714 1,754 1,741 1,691 1,658
Dividend per share announced 1.54$ 1.20$ 0.93$ 0.81$ 0.72$
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APPENDIX 2: INCOME STATEMENT FORECAST-PART 2
Inventories 1,686$ 1,623$ 1,537$ 1,458$ 1,302$ 1,030$ 765$ 528$ % of sales 5.50% 5.50% 5.50% 5.50% 5.24% 5.39% 5.11% 4.81%
Accounts receivable, net 2,759$ 2,655$ 2,515$ 2,412$ 2,142$ 1,459$ 993$ 730$ % of sales 9% 9% 9% 9.11% 8.61% 7.63% 6.64% 6.65%
Trade accounts payable 2,452$ 2,360$ 2,236$ 2,183$ 1,554$ 1,298$ 969$ 764$ % of sales 8% 8% 8% 8.24% 6.25% 6.79% 6.48% 6.96%
Change in WC (75)$ (101)$ (130)$ 203$ (699)$ (402)$ (295)$ (494)$ Revenue Change
Equipment and services as % of sales 70.32% 68.32% 65.19% 61.66% 63.48%Annual growth rate 5.0% 7.0% 7.0% 9.64% 36.29% 35.15% 32.31% 8.30%
Licensing as % of sales 29.68% 31.68% 34.81% 38.34% 36.52%Annual growth rate 1.0% 2.0% 2.0% -0.20% 18.36% 16.08% 42.96% 1.54%
Total Revenue % change 3.89% 5.57% 5.52% 6.52% 30.05% 27.84% 36.20% 5.73%Costs & expenses
Cost of equimpent and services revenues as % of sales 35% 35% 37% 40.34% 39.49% 37.11% 32.61% 30.06%Annual % change 8.82% 38.39% 45.50% 47.74% 9.12%
Research and development as % of sales 20.0% 20.0% 20.0% 20.68% 19.98% 20.47% 20.02% 22.32%Annual % change 10.27% 26.87% 30.72% 22.20% 4.52%
Selling, general and adminstrative as % of sales 9.0% 9.0% 9.0% 8.65% 10.13% 11.87% 13.00% 13.69%Annual % change -9.05% 10.93% 16.71% 29.41% 2.80%
Other as % of sales 1.80% 1.80% 1.80% 1.83% 1.33% 0.83% 0.76% 0.00%Annual % change 46.22% 109.49% 38.60% #DIV/0! -100.00%
Total cost % change 3.89% 2.45% 0.06% 7.38% 31.23% 35.32% 36.88% -7.52%Inestment income as % of sales 4.50% 4.50% 4.50% 4.64% 3.88% 4.60% 4.42% 6.98%Annual growht rate 27.39% 9.55% 33.13% -13.71% #DIV/0!
Operating margin 38.70% 38.70% 36.70% 33.14% 32.95% 34.32% 38.02% 40.91%Effective tax rate 15% 18% 15% 14.2% 16.5% 19.5% 19.9% 21.7%
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APPENDIX 3: DCF MODEL
Discount factor 10.75%Long term growth rate 4.0%Year 2014 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023 2014 2025
Revenue 26,487$ 27,948$ 29,503$ 30,651$ 32,184$ 33,632$ 34,978$ 36,377$ 37,832$ 39,345$ 40,919$ 42,555$ %Grow th 5.5% 5.6% 3.9% 5.0% 4.5% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0%
Operating Income 8,778$ 10,257$ 11,418$ 11,862$ 11,586$ 11,771$ 11,892$ 12,368$ 12,863$ 13,377$ 13,912$ 14,469$ Operating Margin 33.1% 36.7% 38.7% 38.7% 36.0% 35.0% 34.0% 34.0% 34.0% 34.0% 34.0% 34.0%
Taxes (1,244)$ (1,539)$ (2,055)$ (1,779)$ (1,738)$ (1,766)$ (1,784)$ (1,855)$ (1,929)$ (2,007)$ (2,087)$ (2,170)$ Tax Rate 14.2% 15.0% 18.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0%
Net Income 7,967$ 8,718$ 9,363$ 10,083$ 9,848$ 10,006$ 10,108$ 10,513$ 10,933$ 11,371$ 11,826$ 12,299$ %Grow th 16.3% 9.4% 7.4% 7.7% -2.3% 1.6% 1.0% 4.0% 4.0% 4.0% 4.0% 4.0%
Depreciation & Amortization 1,150$ 1,258$ 1,328$ 1,379$ 1,448$ 1,513$ 1,574$ 1,637$ 1,702$ 1,771$ 1,841$ 1,915$ % of sales 4.3% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50%
Changes in WC 203$ (130)$ (101)$ (75)$ (97)$ (101)$ (105)$ (109)$ (113)$ (118)$ (123)$ (128)$ % of sales 0.77% 0.46% 0.34% 0.24% 0.30% 0.30% 0.30% 0.30% 0.30% 0.30% 0.30% 0.30%
CapEx 1,185$ 1,258$ 1,328$ 1,379$ 1,448$ 1,513$ 1,574$ 1,637$ 1,702$ 1,771$ 1,841$ 1,915$ CapEx % of sales 4.47% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50%
Free Cash Flow 8,135$ 8,589$ 9,262$ 10,008$ 9,752$ 9,905$ 10,004$ 10,404$ 10,820$ 11,253$ 11,703$ 12,171$
NPV of Cash Flows 63,056 50.8%NPV of terminal value 60,992 49.2% Terminal Value 187,522 Projected Equity Value 124,047 100.0%Free Cash Flow Yield Free Cash Yield 6.49%
Current P/E Terminal P/E 15.2 Projected P/ECurrent EV/EBITDA Terminal EV/EBITDA 2.6 Projected EV/EBITDA
Shares Outstanding 1,714
Current Price 67.97$ Implied equity value/share 72.37$ Upside/(Downside) to DCF 6.48%
Debt - Cash 17,790 Cash/share 10.38
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APPENDIX 4: SENSITIVITY ANALYSIS OF VALUATION
Sensitivity Analysis:72.37$ 9.25% 9.75% 10.25% 10.75% 11.25% 11.75% 12.25% 12.75%
1% 72.42$ 68.07$ 64.19$ 60.71$ 57.58$ 54.75$ 52.18$ 49.83$
2% 77.32$ 72.20$ 67.69$ 63.71$ 60.16$ 56.98$ 54.12$ 51.52$
3% 83.79$ 77.55$ 72.17$ 67.48$ 63.37$ 59.72$ 56.47$ 53.56$
4% 92.73$ 84.77$ 78.07$ 72.37$ 67.46$ 63.17$ 59.40$ 56.07$
5% 105.87$ 95.02$ 86.23$ 78.96$ 72.85$ 67.64$ 63.14$ 59.22$
6% 127.09$ 110.74$ 98.23$ 88.33$ 80.30$ 73.66$ 68.08$ 63.31$ 7% 167.18$ 137.90$ 117.60$ 102.69$ 91.26$ 82.22$ 74.89$ 68.82$
Discount Rate
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Sensitivity Analysis:3.64% 9.25% 9.75% 10.25% 10.75% 11.25% 11.75% 12.25% 12.75%
1% 3.7% -2.5% -8.1% -13.1% -17.5% -21.6% -25.3% -28.6%2% 10.7% 3.4% -3.1% -8.8% -13.8% -18.4% -22.5% -26.2%3% 20.0% 11.1% 3.3% -3.4% -9.3% -14.5% -19.1% -23.3%4% 32.8% 21.4% 11.8% 3.6% -3.4% -9.5% -14.9% -19.7%5% 51.6% 36.1% 23.5% 13.1% 4.3% -3.1% -9.6% -15.2%6% 82.0% 58.6% 40.7% 26.5% 15.0% 5.5% -2.5% -9.3%7% 139.4% 97.5% 68.4% 47.1% 30.7% 17.7% 7.2% -1.4%
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