With Qualcomm's blowout fiscal Q1 earnings report and 2011 guidance now in the books, and its shares soaring today to levels that they haven't seen since August 2008, the company has definitely vindicated those who held on during the cloudy days of 2009 and early 2010. But with so much good news now baked into the stock, it's probably a good time to reset expectations a bit.
Reasons to be positive
Qualcomm investors definitely have reasons to feel good about the future. There's still some market share for the 3G networks from which Qualcomm derives nearly all of its chipset and royalty revenue to take from 2G networks in emerging markets. Further share gains for high-end smartphones at the expense of cheaper phones will be a positive for both chipset prices and phone royalties. And the success of Qualcomm's high-end Snapdragon baseband processor line is dispelling fears that its 3G baseband operations will become a low-margin commodity business.
Qualcomm's business moves are also doing a lot to boost investor enthusiasm. The company both shuttered its money-losing FLO TV mobile television business and sold FLO TV's spectrum to AT&T (NYSE: T) for a healthy $1.9 billion. And by deciding to sell off the Indian 3G spectrum licenses that it recently won, rather than use the spectrum to build out a 3G network in a very competitive market, management is sidestepping the risk of financing another boondoggle.
Then, of course, there's Qualcomm's pending acquisition of Atheros Communications (Nasdaq: ATHR). With one stroke, Qualcomm gets a chance to:
- Cross-sell Atheros' Wi-Fi chipsets to its 3G baseband chipset customers in the mobile phone industry.
- Offer modules featuring both Wi-Fi and 3G/4G connectivity to notebook and tablet manufacturers.
- Diminish the long-term impact of relatively low 4G royalty rates by increasing its reliance on chip sales relative to royalties.
No wonder then that Qualcomm's shares actually went up after the market got wind of the Atheros deal -- in stark contrast to the vast majority of big tech deals in which the acquiring company pays a large premium.
Potential headwinds
With all those positives, why do I think that investors should temper their forward expectations for Qualcomm? There are a few reasons.
- The Verizon iPhone is a mixed blessing. To the extent that sales of a Verizon (NYSE: VZ) iPhone increase smartphone unit shipments and take share from AT&T's iPhones, it's good news for Qualcomm. But to the extent that it takes share from pricey Android phones such as Motorola's Droid X and HTC's Droid Incredible, it's a negative. Thanks to a licensing loophole, royalty payments on iPhones are reported to be much lower than royalty payments on high-end Android phones. In addition, the Qualcomm baseband chip that goes into Verizon iPhones is much cheaper than its Snapdragon chips.
- ASPs will be under pressure. Thanks to booming Android sales and favorable currency rates, Qualcomm's average selling price on royalty-generating devices took off in fiscal Q1, going from a range of $179-$185 in the prior quarter to one of $201-$207. But ASP guidance for the whole of fiscal 2011 was merely set in a range of $190-$200. This probably reflects some headwinds, such as a greater reliance on emerging markets for unit shipments, and increasing price competition among Android manufacturers.
- Chipset competition is heating up. Both Broadcom (Nasdaq: BRCM) and Intel (Nasdaq: INTC) are starting to throw their weight around in the 3G baseband market. And while the Snapdragon is faring well, it still faces tough competition from stand-alone application processors from Samsung, Texas Instruments (NYSE: TXN), and NVIDIA (Nasdaq: NVDA) as well.
Qualcomm's valuation, while not dirt cheap, is still reasonable. The company sports an enterprise value (market cap - net cash and investments) that's less than 16 times its consensus fiscal 2011 earnings estimate, and less than 15 times its consensus fiscal 2012 estimate -- and those estimates are bound to go higher in the aftermath of yesterday's report. If the tech sector as a whole continues to do well, I think Qualcomm has enough going for it to come along for the ride. But with its shares up about 45% since August, I wouldn't count on market-trouncing returns at this point either.
