In an industry that prizes youthful energy, investors have been worried about a midlife crisis at wireless chip giant Qualcomm . Ageists will miss out: Qualcomm is still fit and has the resources to stay healthy and profitable for a good long time.
Qualcomm (ticker: QCOM) dominates the market for communications chips used in smartphones and wireless devices worldwide, and has an estimated three-year lead over competitors in the latest cellular technology, known as LTE. In addition to manufacturing its own chips, it licenses its technology to other chipmakers, which provides a lucrative royalty stream.
It’s a virtuous cycle. The company’s lush cash flow allows it to invest heavily to maintain its technological lead. In the past five years, Qualcomm has invested nearly $15 billion on research and development, easily spending more on wireless chip technology than its largest rivals combined. And it’s sitting on nearly $30 billion in cash. In the fiscal year that ended Sept. 29, the company bought back $4.6 billion worth of stock, reducing shares outstanding by 4%, and it has raised its dividend for 11 straight years. Last week Chief Executive Paul Jacobs told analysts that the firm would return 75% of its free cash flow and increase the dividend by more than earnings growth, which in fiscal 2014 is expected to be 10% to 14%. The stock yields 1.9%.
That earnings growth figure, however, is a far cry from the 30% rate Qualcomm has averaged over the past three years. One reason is that the number of people without a smartphone is shrinking. Another is that more sales are coming from emerging markets, where phone prices are lower, and Qualcomm’s royalties and chip revenue are a function of the average selling price for the phones using its technology or chips.
But Jacobs assured analysts that while its chipset business will “moderate” a bit in 2014, beneficial long-term trends are still intact, such as more frequent phone upgrades in the U.S., the use of video and other data-heavy applications that require more complex chips, and the launch of LTE in China. Last year sales of lower-tier devices, primarily in China, comprised more than $1 billion of the company’s $25 billion in total revenue.
In fiscal 2013, Qualcomm’s sales grew 30%, and earnings grew 12%, to $6.9 billion, or $3.91 a share. The company offered a much more cautious outlook for fiscal 2014, however, forecasting revenue growth of 5% to 11%, to $26 billion to $27.5 billion. Chief operating officer Steve Mollenkopf told Barron’s that despite the “maturation of developed markets, we are still committed to double-digit growth.”
The stock recently hit a 52-week high of $72.43 but has lagged the market and peers. At 14 times 2014 earnings, Qualcomm trades near its historic lows, and is getting little credit for its stable royalty stream and the $17 a share in cash, which has drawn value investors like Oakmark’s Bill Nygren and Omega Advisors’ Leon Cooperman.
Qualcomm’s growth is slowing, but it still stands out. “Very few large tech stocks can grow revenue at a double-digit pace without M&A or buybacks,” says Credit Suisse IT hardware and communications technology analyst Kulbinder Garcha. “Qualcomm can, even without its buybacks.” Garcha thinks the stock can hit $85, more than 15% above where it is now, based on a sum-of-the-parts analysis that values Qualcomm’s chip business in line with peers, despite its better growth prospects.
FOUNDED IN SAN DIEGO in 1985 by Irwin Jacobs, Paul’s father, Qualcomm has expanded well beyond its signature CDMA technology — the basis for 3G wireless technology and the source of Qualcomm’s lucrative royalties. Now the younger Jacobs is targeting the “Internet of things,” where automobiles, health care devices, and the like are continuously connected, and you can, for instance, remotely control lights or appliances in your home, or medical devices send a signal to your smart watch if your glucose levels rise too high. By 2020, Jacobs says there should be 22 connected devices per U.S. home, up from seven now. More devices means more chips.
For investors, Qualcomm offers an attractive way to play the prevalence of mobile devices, without having to pick a winner in the Samsung-Apple battle. Smartphones are still a growing market; industry research firm IDC expects 1.7 billion smart phones to be sold in 2017, up from 724 million last year. IDC forecasts global shipments of smart-connected devices (including tablets) to total almost 1.6 billion in 2013, up 28% from 1.2 billion last year.
Despite the concerns to the contrary, average selling prices have risen over the past three years. Qualcomm expects a modest single-digit price decline over the next five years on the $226 average selling price of the devices its chips are in. Even if there’s a decline in pricing, the royalty business gives Qualcomm an edge. “Come hell or high water they are collecting 3% of the price of virtually every handset sold in the world,” says Josh Spencer, manager of the T. Rowe Price Global Technology fund.
Qualcomm doesn’t have to do anything Herculean. It just needs to continue to boost dividends and buybacks, and to grow at double-digit rates. That should convince investors it shouldn’t be grouped with large technology firms that aren’t aging as gracefully, such as Microsoft (MSFT) and Intel (INTC), which are growing much more slowly. “It’s odd that [Qualcomm] is getting the same treatment, because it doesn’t face the same long-term threats,” says Spencer. He thinks the shares could rise as much as 40% “if the stock comes back into favor.”
By RESHMA KAPADIA / BARRON’S