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Living up to lofty Street expectations seems to have become a habit lately for leading chip manufacturer, Qualcomm (NASDAQ: QCOM ) and the company's fourth-quarter results were not an exception. This was evidenced by a healthy 33% increase in Qualcomm's revenue to $6.48 billion, beating analyst expectations in the process. The company's bottom line also rose by 18% and would have resulted in a similar estimate-beating scenario, had it not been for a $173 million litigation-related charge incurred late into the quarter. This charge pulled down the actual net income figure to a lower-than-expected $0.86 per share.
However, what actually triggered a 6% fall in the stock price was the cautious revenue outlook Qualcomm posted for the current quarter. That also suggests this may be the time to analyze Qualcomm's pros and cons to determine if it pays to hold onto this stock any longer.
Bad news first
The main reason for the disappointing outlook seems to have been an expected slowdown in profits from its high-end chip sales, thanks to a dwindling number of customers opting for expensive smartphones that use these chips. On the other hand, demand for mid-range smartphones has surged, particularly among cost-conscious consumers in emerging markets such as China and India. This is compelling Qualcomm to produce less expensive chips for such handsets leading to lower profit margins.
At the same time, the company's options may be limited, given the fact that it hasn't had much success marketing chips for personal computers and laptops, an area dominated by rival Intel (NASDAQ: INTC ) . But, before you start having second thoughts about Qualcomm, there are a few things to consider.
What's good about it?
Qualcomm's management has already outlined a strategy to reduce the frequency at which the company introduces new processors into the market, even as it concentrates more on low-end products for less expensive handsets. This is a good strategic move, as the demand for mid-range smartphones is steadily increasing in emerging markets like China and India.
Aside from the fact that emerging markets are dominated by cost-conscious customers, a large part of the demand for smartphones in these regions is also fueled by the transition from 2G to 3G network-based technology. Consumers in developed markets, on the other hand, have already transitioned to phones that run on the next generation Long Term Evolution, or LTE, network technology.
The LTE factor
Speaking of LTE, China is also expected to have a similar network in place by the second half of 2014, which should further brighten Qualcomm's long-term prospects. This is because the company is a clear leader in the area of chips designed for LTE technology, having captured almost a 97% share of global LTE-based revenue. At the same time, since LTE-based phones tend to be more expensive, Qualcomm may bounce back into a situation where its chips for such phones start to yield higher profit margins again. This is what may have prompted management to predict a decline of only $3 in the average selling prices of smartphones in the coming year.
Qualcomm is also increasingly foraying into new areas of revenue generation by manufacturing chips embedded in a range of home appliances such as power switches and thermostats. Additionally, the company's iconic Snapdragon processors are also finding their way into new tablet products announced by Google and Amazon in recent months.
Is anyone else home?
The competition, on the other hand, seems to be generations behind as far as making chips for smartphones is concerned. More than 80% of Intel's revenue continues to be derived from the PC industry that, in itself, has recorded the sixth consecutive quarterly decline in shipments, according to research firm IDC. Any further inroads that Intel is trying to make into the tablet market through its Bay Trail line of processors might have already faced a setback due to competition from Apple's newly launched range of iPads.
Qualcomm's other long-term rival, NVIDIA (NASDAQ: NVDA ) doesn't seem to be doing too well either, as the latter's revenue guidance for the ongoing quarter failed to live up to Street estimates. Facing stiff competition from less expensive chips manufactured by local Chinese companies, NVIDIA posted a whopping 54% decline in sales of its flagship Tegra line of mobile processors.
Foolish final thoughts
Qualcomm's currently announced plans to cut back on growing operating expenses are an important indicator that the company is making a dedicated effort to counter the expected decline in profits. As far as the long-term scenario is concerned, Qualcomm's fortunes should be boosted by the expected LTE launch in China next year.
This is a company that's still the undisputed global leader for LTE-based chips, and has a stable financial position with $29.4 billion in cash and marketable securities, as reported at the end of the fourth quarter. While this may not be the right time to make fresh acquisitions, patient investors should be able to strike it rich once again by the end of next year.
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