Qualcomm (NASDAQ:QCOM) investors heaved a sigh of relief after the company beat Wall Street expectations quite comfortably during the recently reported fourth quarter. The chipmaker has been down so far in 2017, losing over 15% of its market capitalization. But the latest results seem to have given Qualcomm shares a new lease on life.
The stock was up in the post-earnings action as Qualcomm rounded off a better-than-expected quarterly performance with strong guidance numbers. The company closed the quarter with $5.9 billion in revenue, which was in line with consensus estimates. More importantly, its adjusted earnings per share of $0.92 per share was ahead of the $0.90 per share estimate that analysts were looking for.
Qualcomm investors are celebrating the strong showing of its chip business, which can deliver long-term gains as the company taps fast-growing markets outside mobile. However, investors shouldn't throw caution to the winds as the company's successes are being undermined by the alarming erosion of the royalty business. Let's take a closer look at both aspects.
Qualcomm's diversification is reaping results
Revenue from the Qualcomm CDMA Technologies (QCT) business rose 13% during the latest quarter to $4.6 billion, driven by a 4% year-over-year increase in chip shipments. More importantly, the earnings before taxes (EBT) from this segment shot up 4% year over year thanks to a combination of higher chip shipments, a higher-margin product mix, and cost reduction efforts.
The EBT margin of this business now stands at 21% as compared to 17% in the year-ago period. This is good news for Qualcomm investors as QCT now supplies 78% of total revenue.
Looking ahead, the QCT business should keep getting better on the back of a few solid catalysts, such as Qualcomm's foray into chip markets beyond smartphones. Last quarter, the chipmaker pulled in just over $3 billion in revenue by supplying chips for fast-growing markets such as the Internet of Things (IoT) and automotive.
More specifically, Qualcomm's revenue from these non-mobile businesses shot up 25% year over year. This isn't surprising as the company has been trying to make a dent in markets such as 3D sensing and smart homes, setting itself up for future growth even if the mobile business remains under duress.
And Qualcomm's chips are finding tremendous traction in the Chinese market. Late last year, major Chinese smartphone players such as Oppo and Vivo decided to turn to Qualcomm for their smartphone chips, ditching MediaTek. Not surprisingly, MediaTek's revenue during the last reported quarter fell almost 20% year over year.
Qualcomm is pulling the right strings to boost its chip sales outside of Apple, which is reportedly trying to eliminate its components from its devices. But will this be enough to boost Qualcomm's overall business, in the long run, especially considering that its technology business is being decimated thanks to the Apple royalty feud?
The technology licensing business is down in the dumps
Qualcomm's revenue from the technology licensing business fell 36% year over year. Though this business now accounts for just over 20% of the top line, it supplies almost half of the company's EBT because of lucrative royalty deals. However, this segment is losing its sheen after Apple objected to Qualcomm's royalty structure and directed its component suppliers to withhold payments. This seems to have inspired other companies to withhold royalty payments as well.
Qualcomm admitted that another licensee has been disputing royalty payments to the chipmaker. This could be Huawei, according to Foolish colleague Leo Sun, which is bad news for the chipmaker given the Chinese company's growing clout over the smartphone space. Furthermore, if Huawei is indeed withholding royalty payments to Apple, fellow Chinese smartphone makers such as Oppo and Vivo could also consider following suit.
The technology licensing business' EBT margin fell 16% year over year to 68% during the last-reported quarter as licensees either underpaid or didn't pay any royalty at all. The bad news is that there is no respite in sight as Qualcomm expects the licensees to take such actions until a resolution is reached.
There is, however, no resolution in sight as the Apple-Qualcomm feud has taken a turn for the worse of late. Qualcomm has now accused Apple of violating its software license contract and sharing its software code with Intel. This accusation comes just after it emerged that Apple is planning to drop Qualcomm chips from its iPhones and iPads starting next year.
Moreover, Qualcomm's general counsel believes that the warring parties won't be settling their legal battles anytime soon, so the chipmaker will find it difficult to get its bottom line growth back on track. This spells trouble for Qualcomm investors given the impact of the licensing business on the company's overall earnings.
Last quarter, the company's non-GAAP net income fell almost 28% year over year as the headwinds in the licensing business dented its overall EBT margin. Therefore, the protracted legal battle with Apple and a potential domino effect will lead to further erosion in Qualcomm's earnings.
The company's guidance indicates that Qualcomm expects its licensing revenue to drop in the range of 28%-39% during the current quarter, which could reduce its adjusted earnings per share by 20%-29%. Bulls will point out that Qualcomm is making progress in chip sales by targeting fast-growing opportunities, but the grim reality is that the licensing business holds a bigger sway over its profits and it isn't going to get back on track anytime soon.