Did Qualcomm Sandbag Guidance?

Who got rich in the California gold rush? The stories you hear on the History channel are ones about guys like James Marshall, who simply put his hand into a river and picked up gold nuggets the size of peas. Some of the miners made a killing, but the people who made consistent income were the ones selling blue jeans to the 49ers. Why am I bringing this up? This is what Qualcomm  (NASDAQ: QCOM  ) is doing for the device industry. If you have a device, any device, and want it to be connected on a CDMA network, you have to pay Qualcomm for licensing its intellectual property.

We are at a point where the number of devices connected to carrier networks is exploding, as smartphone adoption in emerging markets is at its infancy and tablets are being connected to carrier networks. Regardless of whether the handset provider is Apple or Motorola, or the carrier is China Mobile or British Telecom, Qualcomm gets paid. It is these trends that caused Qualcomm to beat its consensus earnings by $0.08.

Results were good, guidance was weak 
For the quarter ending December, revenue of $6.62 billion was lighter than consensus of $6.69 billion, but EPS of $1.26 handily beat the $1.18 EPS estimate. Guidance for the coming quarter of $6.3 billion and $1.20 at the midpoints was below consensus of $6.69 billion and 1.26, but the company raised guidance on the full year, which ended up supporting the stock after hours and through the open.

Revenue drivers look solid
It is difficult to handicap earnings from one quarter to the next, but Qualcomm's fundamentals are stellar. In fact, one of the key metrics behind revenue growth is actually accelerating. MSM chip unit shipments accelerated from 2012 to 2013 as the year-over-year growth rate actually jumped from 18% to 21%. How many companies can you find that are seeing growth in unit shipments jump on a 600 million number?


Source: Qualcomm

Qualcomm's big concern
The biggest concern for the company though is China's NDRC possibly levying a fine as large as $1 billion for violating an anti-monopoly law in China. Under the anti monopoly law, the NDRC can levy fines of between 1%-10% of a company's revenue from the preceding year. Qualcomm generated $12.3 billion for its 2013 fiscal year according to the company.  

The rationale behind this investigation is likely the upcoming 4G bonanza. Chinese telecom firms are expected to upgrade to 4G in the coming years, and as the infrastructure build out occurs, Qualcomm stands to cash in on a windfall. This investigation may be a tactic used in the negotiation of royalties that Chinese firms will be expected to pay in the coming years. 

Did Qualcomm sandbag guidance?  
As an investor, you have to wonder if Qualcomm sandbagged guidance because of this unpredictable issue. It certainly wouldn't help in the negotiations if the estimates and share prices were booming because of business being closed in China.  As it stands, China represented half of Qualcomm's total revenue in the prior year, so resolving this issue on favorable terms is critical for the company going forward.  As an investor, I don't like to buy companies that have an unpredictable binary event in their future. Outside of that issue, the underlying business metrics look solid.

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