Qualcomm Delivers Record Q4 Results But Disappoints With Guidance As ASP Concerns Catch Up

Qualcomm (NASDAQ:QCOM) reported a solid set of Q4 FY 2013 results Wednesday, as strong growth in chipset sales and licensing fees helped revenues grow 33% year-over-year and come in close to the high end of its guidance. Earnings per share also registered strong growth of 18% y-o-y, but could have been even better had it not been for a one-time litigation expense of $173 million. The results were driven by sustained growth in demand for mobile devices as well as the ongoing transition to 4G LTE in many parts of the world, which helped chipset shipments beat guidance by reaching a record level of 190 million. At the same time, increasing 3G penetration in emerging markets such as China gave Qualcomm a wider base to collect royalties from, helping licensing revenues grow by 19% y-o-y. With shipments of 3G/4G mobile devices growing strongly, the company increased its 2013 guidance for the same by 5% to 1.1 billion units at the mid-point.

However, shares fell almost 4% as the company set moderate growth expectations for the next fiscal year. Qualcomm expects FY 2014 revenues to grow by only 5-11% – a sharp decline from the average revenue growth rate of 31% it delivered in the last three years. While unit sales are expected to be strong, a growing mix of emerging market sales as well as slowing demand for high-end smartphones are likely to push ASP levels down, both for chipsets and well as mobile devices. The company expects to get more cost-efficient over time in order to offset that impact by growing operating profits at a faster rate than revenues, but doesn’t expect results to reflect that before the second half of next year. Higher shipments of LTE smartphones as China transitions to the new 4G standard are likely to provide some near-term support to the ASP levels, but we expect that to be offset by a broader decline in smartphone prices due to intensifying competition at the low end. We have slightly revised our price estimate for Qualcomm to $71.50, about 7% ahead of the current market price.

See our complete analysis for Qualcomm stock here

Emerging Markets Will Drive Qualcomm’s future growth

The smartphone market has shown 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. The consumer shift to 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 78% in 2012 to 128 million units, and will continue to grow rapidly for the next few years to reach more than 400 million unit sales by the end of 2017. ^[1]

Most of the future smartphone volume growth is likely to come from emerging markets such as China and India, where 3G/4G penetration is still very low  and carriers are intent on driving data usage through smartphones. 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. With a billion-strong mobile subscriber base and carriers increasingly trying to transition their 2G bases 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).

The biggest opportunity for Qualcomm there is China Mobile, which is planning to transition from its TD-SCDMA standard to 4G LTE. China Mobile is not only China’s largest wireless carrier, but also the world’s, with a subscriber base of over 750 million that overshadows Verizon’s by almost seven times. Given Qualcomm’s early lead in LTE and its relatively low presence in the earlier standard TD-SCDMA, China’s transition to LTE should not only give it a wider base from which it can collect royalties, but also to further its chipset market share.

ASP Decline Likely To Offset Growth In Unit Sales

However, an increasing mix of mobile phones sold in emerging markets will cause mobile ASPs to fall, limiting the upside to both chipset revenues as well as licensing fees. The company saw its chipset ASP decline by 4% sequentially due to a higher mix of lower-priced chipsets, and expects this to continue next quarter as well. It also expects its mobile device ASP to decline by 1% in FY2014. Most of the expected decline is likely due to China’s emergence as a potential 4G powerhouse in the coming years, with the government expected to hand out LTE licenses by the end of 2013. In preparation, China Mobile and China Telecom have already awarded contracts to infrastructure vendors such as Huawei, ZTE and Alcatel Lucent to build out their respective LTE networks. Up until now, LTE compatibility was an essential requirement for handsets only in the U.S. market. But China’s LTE foray will see handset manufacturers start to increasingly support 4G in their low-end smartphones as well.

The impact from this trend on Qualcomm is twofold. Rising low-end penetration of LTE will not only cause Qualcomm to lose market share to emerging market rivals such as MediaTek, which is to be somewhat expected considering that Qualcomm accounts for over 95% of the LTE market currently, but also hurt its pricing power as 4G becomes more mainstream. Qualcomm’s near-monopolistic hold on the LTE market has so far helped it command a premium pricing in the market, which we expect to continue in the near term as well. From less than $17 in 2010, Qualcomm’s chipset ASP has risen to over $23 in FY2013. In the longer run, however, the gradual proliferation of LTE handsets should cause chipset prices to fall in a maturing LTE market.

In addition to a loss of LTE market share, a decline in chipset prices will cause LTE handsets to become cheaper as well, directly impacting Qualcomm’s licensing revenues. Since Qualcomm’s 3G/4G technology is widely used in handsets, it collects a certain percentage of the price of smartphones sold as royalty. This makes handset ASP a very important driver of its high-margin licensing business, which accounts for almost half of Qualcomm’s value by our estimates. Growing LTE penetration at the high end has been one of the reasons behind handset prices rising by more than 15% since 2010. But as the technology gets widely adopted in emerging markets such as China, handset ASPs are likely to face increasing pressure in the coming years.

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1. Tablet Shipments Forecast to Top Total PC Shipments in the Fourth Quarter of 2013 and Annually by 2015, According to IDC, IDC Press Release, September 19th, 2012 [↩]