Qualcomm (NASDAQ:QCOM) reported revenues of $6.8 billion in Q2 2014,experiencing 9% year-over-year and 7% quarter-to-quarter growth, mainly driven by record performance in the ‘Qualcomm CDMA Technologies’ (QCT) segment. Though the growth rate was higher compared to Q2 2014, it is still way below the historical growth rate of over 20% that the company reported in the last few quarters. Qualcomm’s top line growth has been impacted by a maturing high end smartphone market and increasing demand from cost-sensitive emerging markets such as China.
Backed by improving operational efficiency, Qualcomm witnessed a 40% annual and 10% sequential growth in its non-GAAP earnings per share ($1.44), which was a healthy $0.24 above the midpoint of the guidance range. Though it continues to make critical investments in its roadmap and supply chain initiatives, Qualcomm remains committed at exiting fiscal 2014 at an overall operating expense run rate lower than last year.
The company shipped a record 225 million Mobile Station Modem (MSM) solutions in Q3 2014, well ahead of its expectations, driven primarily by increasing shipments to Chinese manufacturers for 3G and 3G LTE devices. Revenue from the MSM chip shipments were up 31% year over year, respectively. However, the Qualcomm Technology Licensing (QTL) device sales and revenue were lower than expected, as a result of a dispute with Qualcomm licensees, under reporting by certain licensees, and sales of certain unlicensed devices in China. Qualcomm reported a 3% sequential and 13% annual decline in its QTL revenue.
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Qualcomm expected the second half of the year to be substantially better than the first half, as LTE sales ramp up in China and its cost-cutting efforts show their full impact. Owing to the strong performance on the margins front, Qualcomm has increased its fiscal-year EPS guidance.
Our price estimate of $73.86 for Qualcomm is at an approximate 10% discount to the current market price. We are in the process of updating our valuation for the company.
Growth of 3G/4G LTE Wireless Technologies In Emerging Markets To Drive Growth; China LTE Transition Offers The Biggest Opportunity
Being the No. 1 player in chips, growth in Q3 2014 was primarily driven by broad-based demand for Qualcomm’s 3G and multimode 3G/4G chipsets. The total 3G/4G device demand in the quarter was stronger than company expectation, as it continued to see healthy end user device demand. In addition to China, the company claims to be seeing strength in its 3G portfolio in other markets such as Latin America. Driven by the better than expected chip demand, Qualcomm now expects 3G/4G device demand, excluding TD-SCDMA GSM devices, for calendar 2014 to be at the high end of the 1.22 billion to 1.30 billion device range which it provided last quarter, reflecting strength in both developed and emerging markets.
The biggest opportunity for Qualcomm in China is China Mobile, which is transitioning from its TD-SCDMA standard to TD-LTE. China Mobile is not only China’s largest wireless carrier, but also the world’s, with a subscriber base of over 760 million. Its market share of Chinese wireless subscribers stands at about 65% currently. Qualcomm faced some headwinds in China last quarter, as customers deferred buying decisions in anticipation of China Mobile’s LTE foray and retailers aggressively moved TD-SCDMA inventory to make way for TD-LTE handsets.
China Mobile hasn’t been able to leverage its dominance in the overall market to drive 3G adoption in the country due to shortcomings with the TD-SCDMA standard, which wasn’t widely supported by handset makers. With the TD-LTE transition, China Mobile is looking to offset the 3G disadvantage and make up for lost time. This provides Qualcomm with a big opportunity to further its LTE dominance and gain baseband market share in China, especially now that the carrier will sell only five-mode handsets going forward. Qualcomm will also be looking to leverage its overwhelming LTE lead over rivals to corner a greater portion of chipset sales in China.
Qualcomm has the most mature and widely used portfolio of five-mode chipsets, all developed on its state-of-the-art baseband technology. Thus, we expect it to benefit from China Mobile’s plans to offer five-mode LTE-enabled handsets. Additionally, China Mobile has decided to offer discounts on smartphones that will run on Qualcomm’s superfast 4G LTE network. China Mobile has launched LTE service in over 300 cities, with over 300 LTE device models, and has seen increased data usage in ARPU from its LTE subscribers.
As the company stated to investors: 
“In addition, LTE FDD trial licenses have been granted to both China Unicom and China Telecom. Both operators are launching hybrid LTE TDD and FDD trial networks in 16 cities. We expect those trials to expand to additional cities throughout the year. We are working closely with the operators to help them optimize their networks, and our chipset solutions, which support both the TDD and FDD modes of LTE, provide the mode, band and hand-off combinations they require for their 3G and LTE networks.”
Qualcomm claims that its success to-date in China is based on chipsets that were launched last year. It is on track to commercialize its new low cost architecture with the Snapdragon 410, this quarter. The Snapdragon 410 and follow-on LTE chipsets raises the competitive benchmark and improves product costs.
Anti Monopoly Investigation In China Can Limit Upside Potential In The Region
Qualcomm is facing an anti-monopoly probe in China by the National Development and Reform Commission (NDRC), primarily in its licensing business and certain interactions between the company’s licensing business and chipset business. NDRC has said that it is looking into complaints that Qualcomm is charging a higher royalty rate in China than in other countries. If this is found to be the case, it could jeopardize Qualcomm’s future revenue growth in the region, given that China and its local players are likely to be the biggest drivers of its licensing revenues in the coming years.
In its Q3 2014 earnings call, Qualcomm mentioned that it continues to fully cooperate with the NDRC, but the timing and outcome of any resolution remains uncertain, as does the impact on its future business in China. (Read: Qualcomm’s Regulatory Troubles In China Cast A Shadow Over 4G Opportunity).
Fiscal 2014 Estimates
– Revenue to be in the range of $26.3 billion to $27.2 billion, up approximately 8% year over year and unchanged at the midpoint from the prior guidance.
– Non-GAAP earnings per share to be in the range of $5.21 to $5.36, up approximately 17% year-over-year at the midpoint. This is $0.14 per share higher than the previous guidance midpoint.
– QTL average selling price in the range of $222 to $228.
– Combined non-GAAP R&D and SG&A expense to grow approximately 5% to 6% year-over-year.Notes: