Feb 5 2020 - Quo Vadis Qualcomm? A Breakdown Of This Powerhouse

Qualcomm has struggled with declining sales and profits in recent quarters. Besides, recent years have been marked by legal disputes and antitrust lawsuits around the world.

I would like to highlight some aspects that underscore why Qualcomm and its investors have every reason to look forward to the future.

I remain extremely bullish and expect the company to show rising sales and profits again in the coming quarters. Then I also expect (higher) dividend increases again.

Introduction

Qualcomm (QCOM) has struggled with declining sales and profits in recent quarters. In addition, recent years have been marked by legal disputes and antitrust lawsuits around the world. Investors, in particular, have suffered from this, as the share price has plummeted, in some cases dramatically. In the meantime, however, the picture has cleared up and Qualcomm's share price has reached a new all-time high. 'Quo Vadis Qualcomm?', one or two investors might wonder. And indeed, after the price recovery, it may seem reasonable to sell the shares to save the book profits. However, I think this would be the wrong decision. I believe that the future holds great promise for Qualcomm investors. Why this is the case, I will clarify in the following analysis.

The business

First, it's important to understand Qualcomm's business. Qualcomm's business can be divided into three segments. The business with the highest turnover is the QCT segment. This segment has a broad portfolio of CDMA- and OFDMA-based technologies includes wireless devices and infrastructure integrated circuits. Each of these is used in wireless voice and data communications, networking, application processing, multimedia, and global positioning system products. Apart from some income from licensing, equipment and services account for the bulk of the revenues:

(Source: 2019 results/table by author)

With EBT/revenue under 20 percent, the QCT segment is not that profitable. Here, the second segment becomes relevant. The QTL segment essentially comprises the licenses. QTL "grants licenses or rights to use portions of our intellectual property portfolio that are essential to the manufacture and sale of certain wireless products. Providing access to our leading intellectual property portfolio for wireless technology has been a catalyst for industry growth". As we can see in the table below, the QTL is quite profitable with EBT/revenue was 80 percent in 2017, 68 percent in 2018 and 64 percent in 2019:

(Source: 2019 results/table by author)

Here you can already see how much EBT and revenue are together. In the following overview, you can see how much the two segments differ in profitability and how important the QTL segment is for investors. Although the EBT/revenue ratio is more stable in the QCT segment, it is still more than four times as high in the QTL segment:

(Source: 2019 results/table by author)

A very interesting segment is Qualcomm's investment vehicle segment QSI. "QSI focuses on making strategic investments, many of which are in early-stage companies, that open new, or expand upon, opportunities for our technologies in voice and data communications, as well as new industry segments."

With this vehicle, Qualcomm has launched several Funds to invest in promising areas and Start-ups. Accordingly, Qualcomm has launched the Qualcomm Ventures 5G Ecosystem Fund to invest up to an aggregate of USD 200 million in companies building the 5G ecosystem. Another Fund is the Qualcomm Ventures AI Fund. Qualcomm plans to invest up to USD 100 million in companies transforming AI. The focus is on on-device AI (in particular for autonomous cars, robotics, and machine learning platforms). Another part of the QSI segment is SiFive which is according to Qualcomm "the leading provider of processor core IP based on the free and open RISC-V instruction set architecture and complete silicon solutions." The share in total revenue is only very small. However, EBT in 2019 was was relatively high in return and was primarily driven by gains resulting from the initial public offering of certain non-marketable equity investments:

(Source: 2019 results/table by author)

Dividends and share buybacks

Another thing is Qualcomm's dividend payments and share buybacks for the benefit of investors. Since 2013, the company has massively bought up its shares. If you look at the past ten years, Qualcomm has bought USD 54.5 billion of its shares:

Another aspect that should appeal to dividend investors, in particular, is that Qualcomm is a reliable dividend payer that has increased its dividend for 16 years (however, the dividend was kept stable in 2019). With an average growth of 9 percent over the past five years and a payout ratio of less than 60 percent, the dividend is more than safe. Similarly, the current dividend yield of 2.77 percent, while not exorbitantly high, is higher than the S&P 500 average. So overall, nothing to complain about. The dividend should also be increased again in the second quarter of 2020.

Some investors may criticize the timing of the share buybacks and the recent rather low dividend increases. However, at the time of the share buybacks, the volatility that had occurred in the meantime was not foreseeable. And I think that the management certainly believed that Qualcomm was undervalued. And then it's perfectly okay for it to buy back stock in its own company.

As it concerns the low dividend increases, given the somewhat uncertain overall situation regarding regulatory risks (see below), I think it is reasonable to have some money in hand for the time being.

The outlook

Of course, the first thing you notice is that sales and EBT tend to decline in all segments. Nevertheless, the share price is near its all-time high:

This is essential because the market is looking to the future alone and Qualcomm has an extremely important role to play here. So let's dig into that a little bit more. According to Qualcomm, the future looks indeed promising:

In the coming years, we expect consumer demand for 3G/4G multimode and 4G products and services to decline as new consumer demand for 3G/4G/5G multimode and 5G products and services ramp around the world. We expect growth in new 51 device categories and industries, resulting from the expanding adoption of certain technologies that are already commonly used in smartphones by industry segments outside traditional cellular industries, such as automotive, computing, IoT and networking.

I would like to highlight some aspects that underscore why Qualcomm and its investors have every reason to look forward to the future. On the one hand, we have the smartphone business. Now that Intel has left the market for 5G modems for smartphones, Qualcomm is more or less without competition. This applies above all to the USA and Europe, where Asian competitors such as Huawei have a difficult position for political reasons.

Qualcomm is also turning its attention to other emerging markets that will experience extreme growth, particularly with the introduction of 5G. This concerns in particular "Autonomous driving" and "V2X"

In my last analysis, I took a closer look at the announcements Qualcomm made at CES 2020. Qualcomm announced two things. At first, Qualcomm unveiled the Snapdragon Ride Platform for its automotive division (click here for the press release). The Snapdragon Ride platform will include processors and cloud services. Vehicles with this technology are expected to be on the road by 2023. The platform is intended to support both driver assistance systems and fully autonomous robotics. Furthermore, Qualcomm announced its offering of an integrated, secure connected-car services suite for Qualcomm Snapdragon Automotive Cockpit Platforms and Qualcomm Snapdragon Automotive 4G and 5G Platforms (click here for the press release). This is a big step and was great news for the company because it allows Qualcomm to offer platforms and chip solutions as a bundle. In doing so, the company may even create an ecosystem that provides strong incentives not to change the provider of such solutions.

When it comes to timing, we can now assume that 2020 will be the starting point at which this development begins to be reflected in the revenues and profits of companies like Qualcomm. Accordingly, Qualcomm also expects sales to pick up in 2020 after a weak year in 2019.

(Source: Global 3G/4G/5G device shipment estimates by Qualcomm)

Downside

Of course, possible downside scenarios must also be addressed. Qualcomm is fighting on several fronts. One time it's about competing in the marketplace, another time it's about regulatory threats. The greatest threat probably lies in the current appeal proceedings against the FTC decision. The FTC ruled that Qualcomm's “no license, no chips” policy is anti-competitive. Qualcomm addresses these issues in its filings:

Further, if our appeal in the FTC lawsuit is unsuccessful, it could have a material adverse effect on our business. Any such event could result in a materially negative impact on our financial condition, in which case we would have to significantly cut costs and other uses of cash, including in research and development, significantly impairing our ability to maintain product and technology leadership and invest in next generation technologies such as 5G. Further, depending on the breadth and severity of the circumstances above, we may have to reduce or eliminate our capital return programs, and our ability to timely pay our indebtedness may be impacted. If these events occur, our financial outlook and stock price could decline, possibly significantly. Further, a governmental body in a particular country or region may successfully assert and impose remedies with effects that extend beyond the borders of that country or region.

Now that the Trump government has taken Qualcomm's side, this could increase the company's chances. It should also be noted that the FTC ruling did not prohibit Qualcomm from charging licensing fees in general.

As far as the combination of hardware and software is concerned, other competitors are NVidia (NVDA) and NXP Semiconductor (NXPI). But if investors take the hardware business into account it seems that Qualcomm has a big advantage here because of its strength in super-fast 5G wireless technology. And like I said before, in the future, cloud services and roadside infrastructure are likely to communicate with vehicles via 5G. What I particularly like (and what argues in favor of Qualcomm) is that Qualcomm has managed to compensate for the failed acquisition attempt of NXP relatively quickly with its products.

Conclusion

Qualcomm is a powerhouse. With its chipsets and system software (CDMA technology), the company generates a lot of revenue while its licensing business is extremely profitable. Furthermore, it has been seen that Qualcomm's technology is indispensable even for Apple. Qualcomm is a key player in the smartphone market and is now positioning itself in future mega-markets. I remain extremely bullish and expect the company to show rising sales and profits again in the coming quarters. Then I also expect dividend increases again.

Qualcomm is part of my diversified retirement portfolio. If you enjoyed this article and wish to receive other long-term investment proposals or updates on my latest portfolio research, click "Follow" next to my name at the top of this article, and check "Get email alerts"

Disclosure: I am/we are long QCOM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.