Today's Buy Opportunity: Qualcomm

Welcome to the first installment of "11 O'Clock Stocks." Check back to Fool.com at 11 a.m. ET, and we'll be finding a new great stock idea every weekday for the next 50 days. Not only that, but to prove how much we believe in these stocks, we'll be investing $50,000 across our picks. To hear more about the series, click here to see a video from Motley Fool co-founder Tom Gardner.

It doesn't take an investing genius to see that smartphones are everywhere, and there are opportunities to find long-term winners in the field. However, we're also in the midst of a platform war between Google's (Nasdaq: GOOG  ) Android and Apple's (Nasdaq: AAPL  ) iPhone. As the battle intensifies, there's a tremendous amount of uncertainty about which companies will dominate the field five years from now. However, the one certainty investors can bank on is that small, mobile, connected device demand will continue surging across that time.

And there's one company that is perfectly positioned to profit immensely from that certainty. That's my "11 O'Clock" stock pick: Qualcomm (Nasdaq: QCOM  ) .

Qualcomm Fast Facts

Market Capitalization

$62.7 billion

Industry

Communications Equipment

Revenue (TTM)

$10.7 billion

Earnings (TTM)

$3.2 billion

Cash / Debt

$17.6 billion cash / $1.3 billion debt

Key Competitors

Texas Instruments (NYSE: TXN  ) , Broadcom (NYSE: BRCM  ) , Infineon

Source: Capital IQ, a division of Standard & Poor's.TTM is trailing 12 months. Cash total includes long-term investments.

Qualcomm: A history of innovation
Take a swing by Qualcomm's San Diego headquarters and you'll immediately be greeted with an unusual sight. The company literally has a wall of patents.

Photo courtesy of Barry Dodge. Used with permission under Creative Commons 2.0.


Photo courtesy of Barry Dodge. Used with permission under Creative Commons 2.0.

Qualcomm's proud of its history of innovation and the vast patent portfolio that resulted. The wall's a reminder of that. However, the wall is also a statement of something else:

Qualcomm has patented the technology behind every 3G data network in the world.

If you want to use a phone that can connect to a modern data network, Qualcomm is profiting.

How Qualcomm did it
To understand how Qualcomm gained such vast influence over the telecom industry, you need to take a look at the company's past. Qualcomm was founded by a team of engineering geniuses who had a radical plan to reshape the wireless industry. In the late 1980s cellular networks were extended beyond capacity. Qualcomm believed they had the solution to fix the problem, a technology known as Code Division Multiple Access (CDMA), which was much more efficient than any existing or future technologies.  

However, the wireless industry is standards-driven, and by the time Qualcomm began heavily pushing for their solution, most of the world had already coalesced around a different technology. While Qualcomm's solution worked best on paper, there were a number of powerful detractors who said the technology would never work in real life and loudly opposed CDMA's use. The company was essentially alone, to both patent and promote its technology.

Despite vast challenges, Qualcomm managed to persuade a limited number of wireless companies to go against the industry and adopt its standard. To get support, Qualcomm had to build the handsets for its technology, build the network equipment, and train its partners how to work with this new, complex technology. In short, it was a small start-up that had to do everything required to get a massive network off the ground. The odds against Qualcomm getting traction were staggering, but the company eventually succeeded in widespread adoption of its technology.

The patent king
Qualcomm later got out of capital-intensive fields like making cell phones and network equipment. However, the experience of learning how to best optimize its technology across wireless networks proved invaluable. The company used this experience to build out a massive patent portfolio for its CDMA technology.  

With most patent companies there's uncertainty around whether their patents will hold up or how much money the company can generate from the patents. Not with Qualcomm. In the wireless world, the only two certainties are death and paying Qualcomm. While each of its license contracts differs, Qualcomm has said it typically receives royalties that range between 4%-5% of the wholesale selling price on phones utilizing its technology. Many top of the line smartphones have wholesale prices up to $600. That means Qualcomm could be collecting up to $30 with little to no costs incurred on each of those smartphones flying off the shelves.

To make matters even more compelling, Qualcomm used the knowledge it gained from implementing CDMA to start selling chipsets based on the technology. The company's closely held trade secrets assure that it's extremely competitive in the space. Thanks to that expertise, Qualcomm is one of the largest chip makers in the world.

The buy opportunity
Qualcomm's share price struggled across the last year because of concerns over declining phone selling prices and fear over a transition from 3G networks (the current standard) to newer 4G networks where Qualcomm's patent portfolio is a bit weaker and hasn't withstood the same legal challenges. These concerns are overblown for a couple of reasons.

First, the lower selling prices means Qualcomm collects less royalty revenue per phone. However, the volume gains from emerging countries should more than compensate for any selling price declines in developed countries like the U.S. Many emerging markets are just launching 3G networks, and growth rates should be fantastic in coming years.

Also, the growth of Google's Android has been a huge boon for Qualcomm. Not only have Android sales helped prop selling prices back up, but Qualcomm has scored a number of high-profile wins on Android phones in its chipset business. As Android excels, Qualcomm's own future becomes brighter.

Secondly, Verizon (NYSE: VZ  ) and AT&T (NYSE: T  ) have begun transitioning to 4G wireless networks. Qualcomm still has strong patents behind this technology, stating that its royalty revenue is expected to be 3.25% on the standard that Verizon and AT&T are moving toward. While this royalty rate is less than its 3G, phones will still have to connect to 3G networks over the foreseeable future as 4G networks will mainly focus on urban build-outs. That means Qualcomm's royalty revenues shouldn't take much of a hit from this technology transition.

Also, AT&T's and T-Mobile's recent decisions to upgrade existing 3G networks demonstrate that carriers remain dedicated to maintaining strong 3G networks, even after the next generation of technology rolls out. Reports of 3G's death have been greatly exaggerated.

Bottom line and risks
I have to be honest, when co-Founder Tom Gardner asked me for a stock pick, Qualcomm was at what I considered to be a fire-sale price, about 20% below where the stock's trading today. I still think the stock's a great buy, but it's moved closer to the $50-per-share fair value at which I'd assess the company. So if you want to buy, don't overpay if Qualcomm's price keeps climbing.

In the long run, the greatest threat to the company is legal challenges to its patent portfolio, added competition in its chipset business, and the threat that its technology isn't utilized in future wireless technologies. However, with its position in the driver's seat for both the current and next generation of technology, Qualcomm's an extremely safe bet with some fantastic growth opportunities. If you're looking to get back into the market or build out your portfolio, Qualcomm's a top stock pick to get started.

Come back to Fool.com tomorrow for another great stock pick. "Eleven O'Clock Stock" is sponsored by Motley Fool Stock Advisor. The Motley Fool will wait at least 24 hours after this publication before purchasing shares of Qualcomm. To see an FAQ on "Eleven O'Clock Stock," click here.

Eric Bleeker owns shares of no companies listed above. Google is a Motley Fool Rule Breakers pick. Apple is a Motley Fool Stock Advisor recommendation. The Fool owns shares of Google. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.


Read/Post Comments (25) | Recommend This Article (107)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 26, 2010, at 11:24 AM, TMFRhino wrote:

    If anyone has questions about the company- feel free to fire away and I'll answer them.

    Best,

    Eric Bleeker (the author)

  • Report this Comment On July 26, 2010, at 11:34 AM, REDHEAD751 wrote:

    quan had a loi with vhc...because they have the patents on the security for 4g...seems like a great acquistion esp. selling off one of their divisions...any comments

  • Report this Comment On July 26, 2010, at 11:43 AM, Tygered wrote:

    I bought the stock and am willing to hold for a year. After all, it's only $1000 or about 25 shares. It's very obvious that mobile devices are the wave of the future. I have a Droid now and it's really a hand-held computer. I rarely use the phone function, LOL.

    I love the whole idea of this series. I've been in the market, but I'm always interested in new opportunities.

    Thank you,

  • Report this Comment On July 26, 2010, at 11:43 AM, TMFRhino wrote:

    Sorry Redhead,

    I can't really answer any questions about VHC, not familiar with their patent portfolio, and even if I was... probably couldn't evaluate it.

    Best,

    Eric

  • Report this Comment On July 26, 2010, at 11:59 AM, shivy1 wrote:

    Eric,

    Let me first say this is a great article, but I have a few issues. It seems you are not to bright on the future of QCOM's 4G patent. This worries me as innovation is key for techs like QCOM. I understand you are relying alot of oversee expansion of 3G. However it concerns me that QCOM's foothold in U.S. could fall apart. Can you elaborate on this? Is QCOM ready for 4G? Is it investing sufficient capital and time into it?

    Thank You,

    Tony

  • Report this Comment On July 26, 2010, at 12:05 PM, CustardPies wrote:

    Good article. I think I'm the only one in my neighborhood without a Droid. Qualcomm also has a modest dividend which has been increasing for around seven years now. That's always a good sign for a company. At $39, it's not really cheap right now. However, I'd be on the lookout for any dip into the low 30's for a buying opportunity.

    Thanks for the write-up!

  • Report this Comment On July 26, 2010, at 12:08 PM, TMFRhino wrote:

    Hey Tony,

    Let me first say that Qualcomm's 4G positioning (in LTE, which the industry has coalesced around. Even WiMAX holdout Sprint is now apparently looking at moving to LTE) has strengthened in the past year. They've signed the top 3 OEM's (Nokia nad Samsung included) to LTE licensing deals and have a very strong patent portfolio for the technology. I don't believe their US foothold will necessarily fall apart, as long as the phones are multimodal (have a receiver for 3G and 4G), their royalty rate should stay elevated above pure 4G levels.

    All things considered, the biggest threat in this generation was probably WiMAX. With that technology failing to gain sufficient tractio, I think Qualcomm is well positioned.

    Hope that answers your question.

    Fool on!

    Eric Bleeker (TMFRhino)

  • Report this Comment On July 26, 2010, at 12:15 PM, TMFRhino wrote:

    One quick thing: meant to say multiband above, not multimodal.

    -Eric

  • Report this Comment On July 26, 2010, at 12:22 PM, savvied wrote:

    I love Qualcomm. This was one of two first ever individual stock bought back in 1998/99. I could have made a huge % gain, but held through the HUGE rise and then the tech bust. It is my largest gain of any stock I own.

    Glad to see this is the stock covered. Good article Thank You.

    I'll continue to check back daily.

  • Report this Comment On July 26, 2010, at 2:20 PM, plange01 wrote:

    qualcomm looks good for a short...

  • Report this Comment On July 26, 2010, at 6:27 PM, samedge wrote:

    @Plange01 - I think you're dead wrong and here's why: based on a compelling analysis from the NYT a couple weeks ago, every 1% of the smartphone market that is gained by android-based devices translates to .06 EPS for Qualcomm. This is due to the fact that Qualcomm is part of Google's Open Handset Alliance consortium is the most advanced and dominant chip provider in the group. At current, I know of three wireless providers that have droid phones sold out and on backorder. Unless you have an iPhone and want AT&T's porous service, where do you go? That's right, droid. This is a solid pick by the Fool.

  • Report this Comment On July 26, 2010, at 6:50 PM, plange01 wrote:

    qualcomm is a broken stock. it had a nice run in earlier years but changing market conditions have passed this company by.the fact that it may be a good company does not make it a good stock to make money on.case in point microsoft look at how this famous companys stock has done since it split to $25 a share in 2003 it closed today at $26!

  • Report this Comment On July 26, 2010, at 7:11 PM, TMFRhino wrote:

    Hey samedge,

    I didn't see that specific NY Times piece. Do you have a link handy?

    My colleague Eric Jhonsa wrote a pretty good piece about Qualcomm's gains from continued Android acceptance as well. Its from earnings back in April, but the lessons still apply.

    If you want a look:

    http://www.fool.com/investing/general/2010/04/22/can-expensi...

    Since that article, we've seen Android estimates shoot from 60,000 to 165,000/day. So, the situation has improved quite a bit for Qualcomm.

    Also, I focused on Android in my take on their earnings from last week:

    http://www.fool.com/investing/general/2010/07/22/was-qualcom...

    Thanks!

    Eric Bleeker (TMFRhino)

  • Report this Comment On July 26, 2010, at 7:22 PM, samedge wrote:

    Eric,

    I mixed up two separate articles - one from NYT and the other from Barron's. The Barron's piece from 7/12 was what I was referencing above. Take a look here: http://bit.ly/c1SBqG. Best,

    Sam

  • Report this Comment On July 26, 2010, at 8:00 PM, addisonsm wrote:

    A recently published survey showed that 74% of iPhone users would buy another iPhone. Only 20% of Droid users said they would buy another one. WHile I am sure they will work out the problems at some point, I wouldn't count too much on Droid's contribution to Qualcomm's bottom line until the air clears a bit.

  • Report this Comment On July 26, 2010, at 8:06 PM, samedge wrote:

    @addisonsm: The x-factor you're not considering here is AT&T. Their service is fair at best. I know several folks who've begrudgingly gotten rid of their iPhone strictly BECAUSE of AT&T alone. If you intend to use an iPhone as a phone 5-10% of the time, there is a sacrifice associated with that function. Until AT&T loses that exclusivity, I'll take my chances (12-18 months, I'd say) on a service provider linked to the android.

  • Report this Comment On July 27, 2010, at 10:37 AM, tomd728 wrote:

    QCOM was a great stock when Jacobs Sr.ran it.

    While the CDMA technology should give QCOM a license to print money ....Jacobs Jr. is an imbecile.

    On a chart basis the stock loves to run that high 30s to 50 range.Could be another run here.Don't bet on Sr. Management to guide QCOM any higher.

    Tom

  • Report this Comment On July 29, 2010, at 1:54 PM, zmaze wrote:

    When I say their "wall of patents" I almost choked on my lunch. Q has lost a few billion on a series of patent infringement suits and there are a number of other claimants lining up at the San Diego Courthouse steps. The company is still in a good position over the next 5 years with 4G, but please don't give them a lot of credit for their hard work in research and innovation.

  • Report this Comment On July 31, 2010, at 12:24 AM, weihou258 wrote:

    Many people recommend QCOM. The BBB guy from cnbc had endlessly recommended it too. Thanks for the information.

  • Report this Comment On July 31, 2010, at 12:38 AM, TMFRhino wrote:

    Welhou258,

    Who is the bbb Guy on CNBC? While i'll say its not a distinctly original pick (market cap 60 billion plus)... I feel like some sound analysis shows some great future opportunities.

    Best,

    TMFRhino (Eric Bleeker)

  • Report this Comment On August 01, 2010, at 10:58 PM, JavaChipFool wrote:

    What other sources of revenue do they have? What percent of there revenue is from royalties on smart phones?

    I like the debt / cash ratio- bought some when it took a tumble back in January, and have added a little bit along the way.

  • Report this Comment On August 09, 2010, at 11:57 PM, JavaChipFool wrote:

    anyone, anyone? Buehler?

    What other sources of revenue do they have? What percent of there revenue is from royalties on smart phones?

  • Report this Comment On August 12, 2010, at 11:00 AM, TMFRhino wrote:

    He JavaChipFool,

    I'm on my phone right now, so this will have to be a rough figure. However, they make about $3 billion a year in licensing. This comes with an obscenely high profit margin since it's just basically collecting checks.

    Their chipset business does about $6.5 billion in sales. From there, the get about $1.5 billion in operating profits a year.

    They have a couple other lines of varying profitability. For example, they've long made the GPS systems trucks use. However, for the most part a lot of these other initiatives have been destructive to shareholder value. I'm pleased to see they're getting out of Flo TV, for example.

    Hope that answers your question.

    Thanks,

    Eric Bleeker (TMFRhino)

  • Report this Comment On November 09, 2010, at 11:58 PM, JavaChipFool wrote:

    Thanks - I had some I bought when they had that drop to about $40, and was thinking of holding on to it a little longer. glad I did, and will keep it till droids stop being the new iPhone. One of my rare impulse purchases, you know, when you see a company's price drop for irrational reasons.

  • Report this Comment On November 18, 2010, at 10:29 AM, TMFRhino wrote:

    Nice buy JavaChipFool! I set the price in the article at about $50, but some encouraging events have taken place since (Smartphone demand continuing to surprise, Average selling prices on phones showing stunning gains, QCOM getting 80% penetration in Android phones) that lead me to push this target higher. I don't have a precise number at this point, but I think the thesis stays strong even at $48.

    Best,

    Eric Bleeker (TMFRhino)

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