|Qualcomm FYQ4 On Tap: Bulls See Strength in iPhone, China Risk Priced In |
By Tiernan Ray
Wireless chip titan Qualcomm ( QCOM) reports fiscal Q4 results after the bell this Wednesday, November 5th, the first quarter since the company on July 23rd beat Q3 expectations and raised its year outlook, but also disclosed it is struggling with some vendors in China who are refusing to pay for its technology.
This is also the first report since Apple’s ( AAPL) iPhone 6 was introduced last month, using Qualcomm parts, and the first report since a Samsung Electronics ( 005930KS) reported a decline in its Q3 mobile fortunes. Samsung is, like Apple, a major customer of Qualcomm’s.
The company continues to be under investigation by the Chinese government regarding its licensing business, which charges royalties for phones shipped that use technology for which Qualcomm holds patents.
The Street is modeling $7.04 billion in revenue and $1.32 in EPS. The outlook for the current quarter is pegged at $7.39 billion and $1.43.
Diving headfirst into the China issue, CLSA’s Srini Pajjuri reiterates an Outperform rating on Qualcomm stock, and a $90 price target, writing that he has “limited visibility” into China’s investigation, but that “even if we assume that China royalty revenue goes to zero, the stock is trading at 17x, suggesting that a near worst case scenario is priced in.”
Probably, the most prominent China OEMs have no problem with Qualcomm, he speculates: “we believe most top tier original equipment manufacturers (OEMs) in China such as Huawei, Lenovo, Xiaomi, Coolpad, and ZTE are complying.”
Qualcomm, he opines, is unlikely to agree to strip away royalty demands altogether. Rather, “We believe some combination of a lower rate, certain exclusions, and a fine is more likely.”
Probably, about $1 in EPS is at risk from those refusing in China to pay royalties, estimates Pajjuri:
We estimate the total made-in-China smartphone units to be about 640m in 2014. Excluding TD-SCDMA/2G, we believe Qualcomm’s addressable market is about 455m. Management’s CY14 device outlook assumes that the company won’t collect from about 215m devices. At around $8/device, we estimate that royalties from the remaining ~240m devices account for ~25% of QTL’s earnings or about $0.80-0.85 in EPS. For CY15, we believe $1.00 is a reasonable estimate, excluding which the stock is at 17x or 14.5x EV/FCF.
Pajjuri concludes while China is important, there are plenty of other growth areas for Qualcomm, and he doesn’t see a meaningful risk of spill-over into India, for example:
The primary spillover effect is in markets where Chinese manufacturers export to. In particular, Indian brands such as Micromax, Karbonn, and Lava primarily source from Chinese design houses such as Longcheer, Huaqin, and Tianno. We believe design houses are responsible for paying the royalties as Indian brands do not currently have a CDMA license. Of the 7 design houses we track in China, 2 of them do not appear to have a license. We also suspect underreporting is prevalent here as it’s difficult to track exact shipments.
Pajjuri is modeling $6.946 billion in revenue in Q4, and $1.28 in EPS. For the current quarter, he sees $7.492 billion and $1.50 per share.
Elsewhere, Cowen & Co.’s Timothy Arcuri reiterates an Outperform rating, and an $85 price target, writing that the stock “remains in a holding pattern pending NDRC investigation, and CQ4 Samsung inventory clear-out represents some near-term headwind for QCT,” but he still sees “risk- reward skewed to upside and see F2015 guide as likely good enough (despite the various QTL China challenges) given waning QCT concentration risk, solid double- digit TAM growth and a still-weak competitive landscape.”
Arcuri is modeling $7.01 billion and $1.35, based on shipments of 235 million chipsets, which is just above the low end of the 230 million to 245 million forecast the company offered. But, he writes, “we see potential for upside to both QCT units and margins given low bar to hit F2014 margin guidance (>20% exiting the year) and further LTE share gains in the quarter.” For this quarter, revenue may come in at only $7.32 billion, given chipset sales into Apple for the chipset division will be offset by inventory clearance of Samsung devices.
The licensing division may actually see a bright spot in that “we note December will be the first Q where QTL’s TAM guidance reflects the “potential” of China 4G, given China Mobile’s 4G LTE connection growth outpaced 3G TD-SCDMA.”
Also today, Ehud Gelblum with Citigroup reiterates a Buy rating, and an $88 price target, projecting $7.05 billion in revenue and EPS of $1.33, up from his prior estimate of $1.30, helped by “strong 4G uptake at China Mobile in CQ3, along with strong CQ3 growth at Apple.” Those positive trends caused Gelblum to raise his device shipment estimate above Qualcomm’s forecast, to 250 million.
Gelblum cut his estimate for pricing for Qualcomm, but he’s not changing any assumptions about licensing amidst the China stubble:
Our chip ASP falls to $19.2 from $19.6 to reflect the mix shift of lower ASP chips into CM. Our revised est’s also reflect an increase in our China Mobile LTE shipment forecast back to 80M for 2014 vs the 60M we had modeled after weak 4G LTE sub adds at CM in Q2. In Q3, CM 4G subs grew to 41M, an inflection point that we expect to benefit Qualcomm on the chipset side. Our QTL ests are untouched given the current underreporting issues in China.
Correction: A prior version of this post listed the wrong date for Qualcomm earnings. The report comes out Wednesday, after the close. My apologies for any confusion caused by the error.
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