Why Qualcomm, Inc. Is Still a Long-Term Buy

Here's why the recent sell-off in Qualcomm may be overdone.

Jul 24, 2014 at 10:54PM

Following the release of its earnings results following yesterday's close, shares of wireless giant, Qualcomm (NASDAQ:QCOM) closed down 6.65% during Thursday's trading. Though the company's chip unit absolutely crushed it, as shipments came in well above the high-end of its guidance, its wireless patent licensing unit -- the company's biggest profit driver -- came in a bit soft.

That said, I'd like to make the case that Qualcomm, despite these near-term challenges, is still a good long-term bet. 

Qualcomm's a mobile one-stop shop
It's no secret that, at this point, Qualcomm is the world's most successful mobile-chip provider. However, there's been fierce competition in this space during the last several years. ARM (NASDAQ:ARMH) has made much of the key IP -- like graphics and processors -- that goes into these chips available for pennies per unit in royalty fees.

Though the market for mobile-applications processors has traditionally been difficult and somewhat commoditized, Qualcomm has managed to shine through. First off, the company has shown an ability to address a wide range of product tiers in a way that no other chip vendor has been able to -- even with ARM making it as easy as possible to build competitive products.

On top of that, Qualcomm has focused on integrating as much as possible onto a single chip and, when integration isn't appropriate, providing functionality as part of a complete platform. Qualcomm has worked hard to become the "one-stop shop" for mobile silicon.

Cashing in its chips
This strategy has paid off in spades, and this quarter was a real proof point: The company's chip sales were up 17% year over year to $4.957 billion, and operating profit was up a staggering 51%, to $1.116 billion. With mobile devices continuing to grow nicely, particularly in the low-end and mid-range, it really looks like Qualcomm has the right technology and cost structure to continue to grab the bull by the horns.

The QTL problem
Though Qualcomm's chip business is doing extremely well financially and competitively, it's not the biggest profit driver of its business -- its technology licensing business (known as QTL) is. As a quick reminder, Qualcomm has a bunch of fundamental patents on 3G and 4G wireless technologies that allows it to collect a roughly 3.1% royalty on the selling prices of 3G/4G LTE-capable devices.

Now, with phone-chip shipments on the rise, and with a broad transition worldwide from 2G feature phones to royalty-bearing 3G/4G LTE smartphones, it's a little weird that the company reported QTL sales down 5% year over year, and 15% sequentially. Apparently, Qualcomm thinks so, too.

In fact, Qualcomm made it clear that it believes that certain local Chinese handset vendors are underreporting device shipments by about 215 million units in aggregate for the year. These devices likely carry lower selling prices -- likely in the $100 range -- than the reported averages -- which are usually in the low $200 range -- but even if one assumes an average selling price of $100 for these devices and a 3.1% royalty rate, Qualcomm will be missing out on a full $667 million in royalty revenue for the year.

Ouch.

There's good news, though
The bad news, obviously, is that Qualcomm is missing out on all of this potential operating income. The good news, however, is that this isn't the first time that the company has dealt with these types of issues, and it's very likely that it will (eventually) get resolved. This may impact revenues/profits in the near term; but not only will these units probably come back, but Qualcomm may even be able to collect on these missing royalties at a future date.

Foolish bottom line
Qualcomm's business model is still fine and, over the long run, it's still very nicely exposed to the general growth in wireless through both chips and technology licensing. With approximately $33 billion in cash on the balance sheet, a very robust core business, and a proven track record of technological leadership and execution, this drop in the company's share price may prove to be a compelling entry point for investors who may have been waiting for a "dip" to buy.

This tech stock could be even more exciting than Qualcomm
Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out, and some early viewers are claiming its everyday impact could trump the iPod, iPhone, and the iPad. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!

Ashraf Eassa owns shares of ARM Holdings. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple and Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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