Qualcomm (NASDAQ:QCOM) delivered record revenues for Q2 FY2013 on April 24, but saw shares decline as investors fretted over its lower-than-expected earnings guidance for the next quarter.
The dominant semiconductor giant rode the growing popularity of mobile devices and the ongoing transition to 4G LTE in many parts of the world, to post a 24% growth in revenues y-o-y. As a result of the sustained strong top line growth, Qualcomm increased its revenue guidance for FY2013, from a range of $23.4-$24.4 billion to $24-$25 billion. However, the immediate next quarter’s earnings guidance came in lower than market expectations, setting off worries that chipset margins are feeling the pressure of increasing competition and growing popularity of low-end smartphones. The average selling price (ASP) of mobile devices has also started to decline after two years of unmitigated growth, making the markets nervous about the corresponding impact on earnings, given that licensing is a bigger contributor to the bottom line than chipsets.
The near term earnings guidance took the sheen off what was otherwise a brilliant quarter for the company, sending shares lower by almost 6% in after hours trading. However, the company maintained its full year operating margin guidance for the chipset and licensing divisions, implying that the later half of the year should pick up the slack as handset makers launch high-end smartphones in preparation for the holiday season.
In the coming quarters, we see Qualcomm benefiting from the 3G to 4G transition in developed markets and the 2G to 3G/4G transition in the emerging markets as it leverages its huge patent portfolio and early LTE lead to keep competition at bay. In the longer term, however, there is likely to be pressure on margins and mobile device ASPs as the mix shifts to emerging markets and LTE competition catches up.
Keeping all these factors in view, we have a revised $70 price estimate for Qualcomm, about 10% ahead of the market.
Mix Shift In Mobile As Saturation Seeps In The Developed World
The smartphone market has showed significant growth in recent years. Gartner estimates that almost 700 million smartphones were shipped worldwide last year, a growth rate of more than 43% over 2011. A consumer shift towards smartphones continues to be strong despite some lingering macroeconomic uncertainty, and it is likely that the momentum will push the smartphone market closer to the 1 billion mark by the end of 2013. At the same time, the growth of other mobile devices such as tablets is picking up serious momentum. IDC estimates that tablet sales grew by over 65% in 2012 to 117 million units, and will continue to grow rapidly for the next few years to reach about 260 million unit sales by 2016. 
Most of the future smartphone volume growth is likely to come from the emerging markets such as China and India as the wireless market in developed countries gets saturated and carriers there look to lengthen the smartphone upgrade cycle to lessen the subsidy impact. According to IDC, more than 210 million smartphones were sold in China last year giving the country a share of almost 30% of the world market and leaving the U.S. far behind. With a billion strong mobile subscriber base and carriers increasingly trying to transition their huge 2G base to 3G, China presents a huge opportunity for Qualcomm, to not only gain from its chipset sales, but also earn a steady stream of licensing revenues. (see Qualcomm Introduces Three New Entry-Level Chipsets To Target Emerging Markets) However, an increasing mix of mobile phones sold in the emerging markets will see mobile ASPs fall, limiting the upside to licensing fees from such a scenario.
We currently estimate that the 2G to 3G/4G transition will see 3G/4G penetration of mobile devices worldwide grow from about 50% currently to about 65% by the end of the forecast period. However, the increasing adoption of smartphones in the emerging markets buoyed by the growing number of low-end affordable smartphone options could see 3G/4G penetration increase to about 80%, by the end of our forecast period. Such a scenario would add a further 10% upside to our price estimate. However, if mobile ASPs fall to about $150 from the current level of $220 simultaneously due to the growing emerging market mix, the upside to our price estimate would be limited to only about 6%.
Qualcomm’s LTE Superiority Preserves High-end Dominance
As for 4G LTE, this high-speed technology is being widely promoted in the developed regions of U.S., Japan and South Korea. Qualcomm has taken a big early lead in this market, having come to market first with its LTE-capable baseband chipsets. Of the 47 million LTE-capable chipsets that were shipped last year, Qualcomm accounted for nearly 86% of the market. This big lead is a testament to the company’s superiority in 3G/4G connectivity solutions, which have helped it perform really well in the smartphone market so far.
As a result, while competitors are only now bringing their first LTE basebands to market, Qualcomm’s chipsets are in their third-generation already. Competition in the LTE market is growing with Samsung and Nvidia having made their Exynos and Tegra line LTE-compatible, but we expect Qualcomm’s technological superiority to help it hold fort in the near term. This could be seen in Samsung’s decision to launch the Galaxy S4 with Qualcomm’s chipsets for LTE markets despite having a LTE-compatible chipset of its own. While Qualcomm’s huge initial market share is likely to decline over time due to increasing competition, the overall growth in the LTE market should help more than offset that impact.Notes:
- IDC Raises Its Worldwide Tablet Forecast on Continued Strong Demand and Forthcoming New Product Launches, IDC Press Release, September 19th, 2012 [↩]