Modoff on QCOM Q3 FY11 Results............................
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Qualcomm : Q3 FY11 Results
Solid results and raised guide
Qualcomm reported solid Q3 results with revenues of $3.6 b, ahead of our estimate of $3.4 b
and consensus of $3.6 b. PF EPS of $0.73 beat our estimate of $0.72 and consensus of
$0.71. The company also raised guidance for the next quarter. We think Qualcomm's solid
product portfolio and WCDMA share above 50% provides support for continued good results
through the year - meriting our Buy rating.
Pricing trends continue to improve
Pricing appears to be headed in a positive direction after last year’s weak mix shift.
Additionally, concerns that the Chinese market may require lower-pricing now seems to be
overblown. The company has shown ability to cost-down products on smaller geometries to
address this market. They are now shipping their 7xxx series basebands with integrated apps
processors likely at or above corporate gross margin averages. We believe these trends will
continue to persist and provide leverage to their operating model.
Smartphone shipments continue upward trajectory
Despite the widely-held belief that smartphone shipments are slowing, we see the opposite.
It is a market share shift taking place among handset vendors. With Motorola, Sony Ericsson,
RIM and Nokia ceding share while Samsung and HTC continue do well. We think the market
is likely undercounting the growing share of smartphones from ZTE and Huawei, both large
Qualcomm customers. Apple will likely ship new phones next quarter and we believe
Qualcomm is set to gain baseband sockets in those new models as well. Overall,
Qualcomm’s competitive position is strong enough that OEM share shifts generally work to
the company’s benefit.
Maintain our Buy rating, raising estimates and price target to $67 from $65
Conclusions This was another good quarter from Qualcomm. Market sentiment has turned negative on
tech recently, but we found little to complain about in Qualcomm’s numbers. In fact, we
were surprised that the market has reacted somewhat negatively to numbers – with the
stock off after-hours, most questions taking a negative slant on the call and a limited number
of investor calls since the print. Apparently, the glass is now officially half empty, or maybe
one-third empty.
For those inclined to look at those negatives, we found a few nits in today’s numbers. QCT
margins were below our expectations, at 20% to our 22.5% estimate. This includes some
dilution from Atheros which has lower margins overall. Teasing the numbers apart though is
difficult as there were only five weeks of Atheros in Qualcomm numbers, and this typically
means the acquirer is incurring the full costs of the target without getting the full revenue
impact. A second complaint we heard from investors was that MSM Q4 guidance were
below expectations at 120 million to 125 million, but in line with our 124 million estimate.
This strikes us as ironic given that all last year everyone was concerned that unit shipments
were too high but revenue was light as mix shifted to lower priced chips. We will gladly
accept more revenue and higher priced chips. A third minor issue was the company lowered
their expectation for CDMA shipments globally for 2011, but this was offset by raised their
estimates for WCDMA, for a net increase to their forecast of 5 million units.
Of all these issues, the only one that we consider meaningful is QCT margins. As noted, the
addition of Atheros skews this metric slightly. The company reported that Atheros
contributed $100 million in revenue and $10 million in net income to Qualcomm on five
weeks of results. By contrast, our somewhat dated Atheros model was looking for $256
million in Q2 Atheros revenue and $45 million in net income. So Qualcomm recorded 40% of
Atheros revenues, but only 22% of net income. To us, this implies a timing issue common to
all acquisitions. For the year, we had modeled Atheros operating margins at 20%, this is
somewhat dilutive to the 24% we had been modeling for Qualcomm. So we expect some
erosion in operating margin percentage, but we suspect that cost synergies will come into
play and mute even that impact.
The company also indicated they expect to continue to add cost to QCT R&D next quarter.
The company is on track to spend $2.5 billion in R&D this year. That is a large amount, but
appears to be fully seen in the marketplace. We were particularly encouraged by the early
sampling of the quad-core MSM8960 which is being targeted at Windows 8 (i.e. Big
Windows, not Mobile) devices as well as smartphones. As these products are not likely to be
on the market until late next year, it is important that Qualcomm can be early to the game.
While we are cautious about how much impact ARM-based laptops will have on the overall
PC landscape, we see it as a positive that Qualcomm continues to execute well on many
product fronts.
We see many things to be positive about in the quarter. A year ago, the Street was grappling
with negative mix shift at Qualcomm as low-priced dongles and emerging markets feature
phones swamped numbers. That trend seems to be operating in reverse, with the company
noting several instances of prices going up. Qualcomm-licensed devices are becoming more
expensive as the category expands to include tablets and ever-more-high-powered
smartphones. Six months ago, we expressed concern that the company might have to lower
pricing expectations as their business among Chinese handset vendors picked up. As noted
in our commentary after our latest trip to China, this concern is easing. Owing to a variety of
factors, Qualcomm is now able to pick up considerable share among the so-called shanzhai
without having to get price aggressive or dip down their normal cost curve. An important
dynamic here is the company’s ability to cost-down products on smaller geometries to
address this market. In particular, the company is shipping 7xxx series basebands with
integrated applications processors. These are going into a huge array of emerging markets
smartphones, but likely offer gross margins at or above corporate averages. The company
implied as much in their commentary noting that integrated applications processors are
gaining traction across their product range.
Prior to the call, the Street was concerned that smartphone shipments are slowing. We see
no sign of this. Importantly, there is a market share shift taking place among handset
vendors. With Motorola, Sony Ericsson, RIM and Nokia ceding share while Samsung and
HTC continue do well. We think the market is likely undercounting the growing share of
smartphones from ZTE and Huawei, both large Qualcomm customers. ZTE is now likely one
of Qualcomm’s largest customers. It is also goes without saying that Apple will likely ship
new phones next quarter, and we believe Qualcomm is set to gain baseband sockets in
those new models. The build for that should start soon, but we expect more of the volume to
come in the December quarter. Overall, Qualcomm’s competitive position is strong enough
that OEM share shifts generally work to the company’s benefit. (We detailed this in our State
of the Baseband S2N note last month.)
In sum, we think this was a solid quarter for Qualcomm. We see nothing of substance to
alter this view in today’s results. We think the company’s solid product portfolio and
WCDMA share approaching 50% provides support for continued good results through the
year. We reiterate our Buy rating and raise our price target from $65 to $67..
Valuation & Risks
Downside risks include slower than expected industry growth rates, particularly for the adoption and growth of 3G networks and consumer demand, a slower than expected
expansion of CDMA and WCDMA in emerging markets such as China and India. The
company could also experience greater than anticipated competition in several of its market
segments, especially in WCDMA. Finally, Qualcomm operates under the threat of an ITC
injunction banning imports of its customers’ products into the US. We cannot handicap the
outcome of this or any other pending litigation. |
