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Segmenting Qualcomm

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By MochaLatte
January 30, 2001

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Segmenting Qualcomm

This post on the Qualcomm board got me thinking about Qualcomm in terms of its business segments. As you can see from their last quarterly press release , QCOM breaks its numbers out according to its 3 biggest segments.

Here is segment information from QCOM's last 10-Q filing:

"The Company is organized on the basis of products and services. Reportable segments are as follows: QUALCOMM CDMA Technologies (QCT) is a leading developer and supplier worldwide of CDMA-based wireless communication integrated circuits and system and applications software solutions for voice and data communications products and services; QUALCOMM Technology Licensing (QTL) licenses third parties to design, manufacture, and sell products incorporating the Company's technologies; and QUALCOMM Wireless Systems (QWS) designs, manufactures, markets, and deploys infrastructure and handset products for use in terrestrial and non-terrestrial CDMA wireless and satellite networks and provides satellite-based two-way data messaging, position reporting equipment and services to transportation companies. The Company sold its terrestrial-based CDMA wireless consumer phone business, the former operating segment, QUALCOMM Consumer Products (QCP), to Kyocera Wireless Corp. in February 2000."

QCOM's investor relation section on their web site has 8 quarters' worth of revenues and pretax earnings for each of these segments. The data are pro forma numbers where they have removed revenues and losses attributable to their old infrastructure division. I appended the last quarter's data and here's the compilation.

Revenues QCT QTL QWS adj Total
12/31/98 193.3 74.1 265.6 3.3 536.2
3/31/99 263.4 106.5 178.5 9.3 557.7
6/30/99 318.3 126.0 190.5 9.9 644.7
9/30/99 358.4 147.6 208.6 1.7 716.3
12/31/99 352.4 177.5 215.0 18.8 763.7
3/31/00 279.2 167.7 188.3 13.6 648.8
6/30/00 338.1 174.2 167.2 34.0 713.5
9/30/00 269.0 186.0 150.5 30.0 635.4
12/31/00 330.1 223.5 92.8 37.6 684.0


Pretax Earnings QCT QTL QWS adj Total
12/31/98 63.9 62.3 51.5 -32.4 145.3
3/31/99 109.0 93.8 25.5 -44.5 183.8
6/30/99 129.5 112.8 37.6 -40.5 239.5
9/30/99 125.6 136.1 51.7 -31.9 281.4
12/31/99 127.7 162.6 66.1 -18.3 338.2
3/31/00 90.0 150.4 83.0 10.1 333.6
6/30/00 109.6 152.4 65.1 24.7 351.7
9/30/00 64.3 167.9 57.9 12.4 302.5
12/31/00 83.8 210.8 7.9 53.9 356.3

It is a simple matter of division to get to the pretax profit margins. Since it is probably pretty meaningless to talk about margins for the "adj" category, I didn't include them.

Pretax Margin QCT QTL QWS adj Total
12/31/98 33% 84% 19% 27%
3/31/99 41% 88% 14% 33%
6/30/99 41% 90% 20% 37%
9/30/99 35% 92% 25% 39%
12/31/99 36% 92% 31% 44%
3/31/00 32% 90% 44% 51%
6/30/00 32% 87% 39% 49%
9/30/00 24% 90% 38% 48%
12/31/00 25% 94% 8% 52%

I can see why QCOM is taking the trouble to make the data so readily available on their web site because it really emphasizes the strong growth and profit margins coming out of their licensing segment, QTL. We are talking about 74% annualized growth and pretax margins that haven't dipped below 87% in the last 8 quarters for QTL. Here are the growth rates and the latest TTM numbers for each segment's revenues.

Current Revenue Growth Rates
QCT QTL QWS adj Total
12/31/98 193.3 74.1 265.6 3.3 536.2
12/31/00 330.1 223.5 92.8 37.6 684.0
CAGR 31% 74% -41% 239% 13%
current TTM rev 1216.4 751.4 598.8 115.2 2681.7

In case that total revenue TTM figure is different than you thought it would be, remember that these are pro forma numbers that exclude some infrastructure revenues.

No the question is, what does the future hold for each segment? Here's my stab at some numbers. I always welcome any feedback it might generate.

QCT makes the integrated circuits that go into mobiles and base stations. Revenue growth for this segment has slowed recently, but I can't help but think that some of this is due to the transition periods of two customers that formerly were internal: the infrastructure division that was sold to Ericsson and the handset division that was sold to Kyocera. QCT has an advantage in having direct access to most of the developers that cleared the technical hurdles to make CDMA. My best guess is that QCT will turn around and grow revenues at a CAGR of 35%. I also predict that pretax profit margins will regain some lost ground to 35%, which is lower than what Intel's pretax margins are today.

QTL is similar to Rambus as the patent holders for some critically important technologies for an extremely important technology. I know there is still debate about whether other companies can find technical or legal ways of avoiding paying the QCOM the toll collectors; however, the extreme levels of FUD thrown about on the matter makes me think that QCOM, like RMBS, has solid technical and legal positions. (If they can't be fought on technical or legal grounds, take the battle to the press.) Based on that assumption, QTL should grow revenues pretty much in lock step with CDMA technology overall as it is adopted in the market. Maybe they will lose a little ground if they have to lower their royalty rates at any point (say to win Nokia's favor), but I still think they could have to give some of it up and still grow revenues at 70% CAGR over the next 5 year period. Since QTL may have more litigation costs in the future, I will user a lower pretax profit margin than the trend would indicate and pick 85%.

QWS has been gutted recently with the sale of the infrastructure division and in the accounting decision to not recognize revenues from Globalstar. However, I am convinced that this group is still in business and will grow in the future. If Iridium can still be alive and winning contracts, I feel strongly that Globalstar will immerge from any bankruptcy proceedings that they may go through and will continue to be a significant customer for QCOM. With the Globalstar write-offs in the last quarter, any revenues that they do collect from Globalstar will be considered a bonus to many people; however, I'm prepared to expect it. I'll be a little more conservative and give them a revenue CAGR of 20%. I will also pick a bland pretax profit margin of 20%.

I don't know for sure what is in the revenues for the "adjust" column, but it has a strong growth trend. I'll give it a 20% CAGR and a pretax profit margin of 20% for the fun of it, but it won't have a significant impact on revenues or earnings.

Now add it all up:

QCT QTL QWS adj Total
est. 5 yr rev CAGR 35% 70% 25% 20%
future rev 5454.2 10669.1 1827.3 286.6 18237.2

So from a TTM revenue base today of $2.68 billion, this scenario would take total revenues to $18.24 billion, which corresponds to a CAGR over the 5 year period of 47%.

QCT QTL QWS adj Total
Fut pretax margin 35% 85% 20% 20%
future rev 1909.0 9068.7 365.5 57.3 11400.5

So a future revenues of $18.2 billion with a future earnings of $11.4 billion results in a future pretax profit margin of 63%.

One thing I haven't mentioned yet is the possible Spinco spin-off. I tend to think that it will never happen, that it was a clever ploy to help negotiate royalty contracts. Even if it does happen, I think QCOM will only go through with it if they can fully realize its value.

Now if I have picked reasonable numbers for each of segment's future growth, something that is immediately obvious is that QCOM will still be in the process of transitioning into primarily being a licensing company. As QTL becomes bigger, the company's overall revenue growth rate will still be accelerating in 5 years and their margins will still be improving. Another way of saying that is that their earnings can grow faster CAGR rate than revenues for several years to come. This means significant potential upside for their future valuation or additional room for error now depending on how you want to look at it.

So I'm at a future combined CAGR of 47% and pretax margins of 63%. That's enough talking from me for now. How reasonable are my assumptions?

Mocha