At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.
Lazard lifts Qualcomm
As the trading week wound down on Friday, Qualcomm (Nasdaq: QCOM) shareholders received one last bit of good news, when the tech analysts at Lazard Capital initiated the stock at buy. The shares haven't really responded much to the new rating, but this could be due to the fact that Lazard doesn't have much of a reputation in tech these days, having ceased providing public updates on its recommendations via Briefing.com some years ago. But are investors missing out on a great stock idea, due simply to the obscurity of the analyst making it?
Let's find out.
Qualcomm: Two businesses, but only one direction to go
As Lazard explains in Friday's buy rec, Qualcomm is perhaps uniquely positioned to benefit from a trend toward greater consumer spending on "connected devices" -- smartphones, tablet computers, and the like. The company makes money from this trend in two ways. On the one hand, Qualcomm sells advanced chipsets to communications equipment makers for use in their phones. On the other, Qualcomm licenses its technology to other companies, collecting high-margin royalties every time they sell a phone that incorporates its tech.
And there are a lot of phones out there with "Qualcomm Inside." Qualcomm's customer list reads like a who's who in communications technology, with everyone from Apple (Nasdaq: AAPL) to China's ZTE Corp. making an appearance -- literally A-to-Z. Its licensee list is nearly as long, running Broadcom (Nasdaq: BRCM) all the way to a communication equipment company like Cisco (Nasdaq: CSCO). Basically, if you're in the telecom industry, you're paying a royalty to Qualcomm or cross-licensing some of your best IP.
According to Lazard, Qualcomm collected royalties on about 40% of the handsets sold last year. The analyst projects this figure will rise past 65% over "the next four years," with particularly fast growth occurring in India and China, where customers of mobile providers such as China Unicom (NYSE: CHU) and China Mobile (NYSE: CHL) are expected to transition to Qualcomm's 3G/4G technology from the 2G/Edge tech now prevalent there.
Growth ... and value?
But is this picture that Lazard is painting bright enough to justify Qualcomm's share price? I mean, at 21 times earnings, Qualcomm is a pretty pricey stock. Free cash flow at the company isn't all that much stronger than reported income, so the stock doesn't look significantly cheaper from a P/FCF perspective, either.
And yet, I can't help but wonder if Lazard is right this time. Consider: If Lazard's right about the shift from 2G/Edge to 3G/4G, and if it's also right about global growth in smartphone sales in general, then a move from "40%" share of the royalties market to "over 65%" implies something like 50% revenue growth in Qualcomm's highest margin business. That would account for most of the 16% annual earnings growth that consensus estimates have Qualcomm pegged for over the next five years.
What's more, nearly 90% of the licensing revenues Qualcomm collects translate directly into pre-tax net profit. This being the case, it's not unreasonable to assume that 50%-plus revenue growth at this division would spark even faster earnings growth -- faster growth than most folks on Wall Street expect to see.
Foolish takeaway
Twenty-one times earnings and 16% long-term growth expectations appear to make Qualcomm an expensive stock. But if the company delivers on the licensing revenue growth Lazard sees for it, the stock could actually turn out to be a bargain.
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