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Budget growth in developing markets remains strong, but pickup of Snapdragon 800 was worse than expected

On Thursday Qualcomm, Inc. (QCOM), one of America's largest semiconductor companies, reported its earnings and was treated to a four percent tumble in share prices.

I. Growth Grinds to a Halt

Qualcomm's results for its fiscal Q4 2013 (calendar Q3 2013) were good, but not great.  The company made $6.48B USD in revenue, up 33 percent from a year ago, and better than the $6.35B USD a Bloomberg survey of analysts expected or the $6.346B USD predicted by a Thomson Reuters analyst survey.

But the first symptom of Qualcomm's issues was witnessed in its weakening profit growth.  Net Profit (earnings) was up "only" 18 percent, rising to $1.5B USD ($0.86 USD/share).  Analysts had expected minor slowdown, as U.S. and EU smartphone growth slowed and smartphone pickups in India and China drove sales towards the budget end, where components see lower margins.  But they expected the slowdown to be somewhat less pronounced, estimating earnings of $0.94 USD/share -- a 29 percent increase.

China
China is now leading new smartphone unit sales growth, but it's a less profitable target for chipmakers like Qualcomm and their OEM clients. [Image Source: Chinadangvu]

As with the earnings reports of Apple, Inc. (AAPL) and Samsung Electronics Comp., Ltd. (KSC:005930), this reaction may have the general public scratching their head in puzzlement as they see double digit growth and billion dollar profits.  But to shareholders part of the valuation of shares of Qualcomm and two of its top component clients -- Samsung and Apple -- is based on an expectation of the large, continuous growth in profitability all of these companies have seen in the mobile era.  As that growth has declined investors are reevaluating share prices.

Stacy Rasgon, an analyst at Sanford C. Bernstein & Comp., LLC, comments to Bloomberg, "They’re seeing a bit of a slowdown in chipset [profit].  This wasn’t a bad report, but it's definitely not good."

II. Qualcomm Admits Snapdragon 800 Pickup Has Been Weaker Than Expected

Jim Williams Financial analyst Cody Acree, adds in a Reuters interview, "We know you can't get the same royalty revenue off of a sub-$200 phone that you get off an iPhone or the Galaxy line.  We're seeing evidence that the emerging-market impact is having pressure on revenue and earnings trends and it's forcing the company to react and cut its spending."

Qualcomm

While most of Qualcomm's revenue comes from sales of its Snapdragon line of system-on-a-chip processors for mobile devices and for its chipsets, Bloomberg points out that Qualcomm has something in common with Microsoft Corp. (MSFT) in terms of mobile -- most of its profit in the mobile space comes from patent licensing.

Microsoft is estimated to have made close to a billion dollars last year quarterly, licensing its operating system-heavy patent portfolio to Samsung.  Qualcomm's patent portfolio focuses on hardware, not software, but is also highly valuable pulling in over a billion dollars per quarter in licensing from the likes of Apple, Samsung, et al.

In fiscal Q1 2014 (calendar Q4 2013) Qualcomm expects revenue between $6.3B and $6.9B USD -- analysts surveyed by Bloomberg expected $7.01B USD in revenue.  Profit is expected to rise to between $1.10 and $1.25 USD per share.  Qualcomm estimates that the average price of a phone that uses its CDMA chipsets will fall 1 percent in 2014 to between $216 and $230 USD.

III. New Segments, Fiscal Discipline are Keys to Qualcomm Sustaining Profit Growth in Challenging Market

Qualcomm's CEO Paul E. Jacobs, Ph.D, son of company cofounder Irwin Jacobs, wasn't afraid to admit that his company had made some miscalculations.  He told Reuters that his company had pushed the early release of the Snapdragon 800 -- a mobile processor that significantly outperforms the competition, only to be greeted by slow adoption.  

Snapdragon 800
The Snapdragon 800 has seen slow pickup. [Image Source: Liliputing]

Mobile OEMs were content to mostly use the older Snapdragon 600 and only recently have begun to release models with the newer chip.  For example Samsung is using the Snapdragon 800 chip in its newer Galaxy Note 3 phablet, but thus far has failed to produce the rumored Snapdragon 800-driven Galaxy S4 "Advanced" model some expected.

Snapdragon 800
Snapdragon 800 pickup was worse than expected.

Mr. Jacobs remarks, "What we're trying to do is focus on the highest-growth opportunities.  We are investing heavily in the low end of the market to get our cost structure into a better place."

Faced with the reality that tablet and smartphone growth in developed markets may be tapering, Qualcomm is eyeing new markets.  In September it released a rare first-party device, the "Toq" smartwatch.  The new watch uses Qualcomm's Mirasol display technology -- a low power screen technology that's inspired by the chemical composition of butterfly wings.  Qualcomm believes the technology is a good fit for the wearable space, and hopes Toq will convinced others to license it.

Qualcomm Toq smart watch
Quacomm Toq [Image Source: AnandTech]

In addition to its hope of selling chips, chipsets, and screen technology to the wearable sector, Qualcomm is also hopeful that "connected homes" -- homes with smart thermostats and security/safety sensors -- will see increasing adoption, creating a new space for processor and chipset sales.

Still Qualcomm is also recognizing both of those markets may fail to live up to their hype and is preparing for the worst.  It told analysts that it expects to grow operating expenses (e.g. global employees, facilities, etc.) by only 5 to 7 percent in 2014, down from its average growth rate of 20 percent it's averages over the last few years.
 
Qualcomm is hopeful that the "connected home" trend, featuring products like Nest cellular-enabled thermostats and smoke detectors will take off.

Chief Operating Officer Steve Mollenkopf commented in an investor phone briefing, "In the near term, we’re seeing a little bit of a downshift in terms of tier.  In the second half we continue to see strong units and a little bit stronger mix."

Qualcomm predicted fiscal 2014 sales of $26B to $27.5B USD, a range whose midpoint value skews below the Bloomberg analyst expectation of $27.5B USD.  The midpoint of the earnings prediction for FY2014 would offer an 8 percent increase in revenue.  That would be a massive drop-off in growth from previous years.  Since 2010 Qualcomm has doubled its revenue, growing at a rate of 25 percent or more every year.  Now it expects growth could slow to a quarter of its previous pace.

III. A BlackBerry Bid?

An interesting side note from the Bloomberg report is CEO Jacobs' revelation that Qualcomm is interested in buying Canadian phonemaker BlackBerry, Ltd.'s (TSE:BB) patent portfolio.  BlackBerry was the subject of several potential buyout deals or inquiries.  The top bid came from Fairfax Holdings, Ltd. (TSE:FFH), who was expected to sell off at least some of the OEM's assets.

But as some feared, a deal with Fairfax collapsed during the "due diligence" phase.  Instead, Fairfax and other investors agreed to lend BlackBerry $1B USD in bonds, in exhange for firing its eternally optimistic, but somewhat delusional CEO Thorsten Heins.  
BlackBerry, Ltd.
Qualcomm is greedily eyeing a purchase of BlackBerry's patent portfolio, which could give a nice boost to licensing revenues.

Mr. Heins will be remembered for his weak leadership and bizarre predictions, such as his April assertion that the tablet market would be dead in fie years.  Instead, Mr. Heins' career is dead, and with a market cap of $3.52B USD BlackBerry appears a foot away from the grave, as well.

Given that low valuation, Qualcomm appears content to wait to swoop in later and buy the IP at an even cheaper price.  CEO Jacobs tells Bloomberg, "There were some assets that we were interested in and we were looking at, but obviously they got a new refinancing.  They have their own strategy. We’re waiting to hear where they are headed."

In other words, Qualcomm is ready to wait for BlackBerry to collapse under its own weight, and then make a bid for the IP when Fairfax and other investors turned to a fire sale to try to recover their lost share holdings and debt.

Sources: Reuters, Bloomberg





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