Qualcomm’s Growth In Q4’14 To Be Driven By Higher 3G/4G Device Demand, Though License Business Remains Uncertain
Leading mobile chipmaker Qualcomm (NASDAQ:QCOM) will report its Q4 2014 and fiscal 2014 earnings on November 5th. The company’s top line growth is being restricted by a maturing high end smartphone market and increasing demand from cost-sensitive emerging markets such as China. While growing smartphone penetration in emerging markets is helping keep unit sales high, it is also having an adverse impact on the ASP (average selling price) levels of both mobile chipsets as well as devices. Nevertheless, Qualcomm has managed to defend margins on account of its ongoing cost management initiatives.
Qualcomm expected the second half of fiscal 2014 to be substantially better than the first half, as LTE sales ramp up in China and its cost-cutting efforts show their full impact. The company reported 9% year-over-year and 7% quarter-to-quarter growth in Q3 2014, mainly driven by record performance in the ‘Qualcomm CDMA Technologies’ (QCT) segment. 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.
The company revised its QTL fiscal 2014 outlook and expects a reduction of approximately 8% in total reported device sales for the second half of the year. Owing to the strong performance on the margins front, Qualcomm has increased its fiscal-year EPS guidance.
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Our price estimate of $86 for Qualcomm is marginally lower than the current market price. We will update our valuation after the Q4 2014 earnings release.
See our complete analysis for Qualcomm stock here
Uncertainty Around The Licensing Business To Impact Revenues
Qualcomm witnessed some headwinds in its licensing division, reporting lower than expected revenue from the business in Q3 2014. As a result, the company revised its Qualcomm Technology Licensing (QTL) fiscal 2014 outlook and expects a reduction of approximately 8% in total reported device sales for the second half of the year. The changes reflect certain challenges in China that could prevent the company from collecting royalties on the full 3G/4G device demand in the near term.
Qualcomm is undergoing dispute with one of its licensee which resulted in the non-exclusion of a portion of that licensee shipment in its Q3 2014 results. Concurrently, the company is working with government entities intent on assuring Chinese licensees pay royalty rates comparable to others. Though the company expects to resolve the situation soon, the timing remains uncertain. Additionally, Qualcomm claims that the timing of the LTE launches in China, as well as device composition at China Mobile, has been a bit difficult to forecast. Qualcomm has signed 70 single mode LTE license with Chinese OEMs and still needs to sign agreements with a number of other Chinese OEMs, in order to be able to collect royalties on all three mode devices in China. The company expects to experience a delay in the timing of collection of royalties on these devices.
According to Qualcomm, some of its Chinese licensees are under reporting and may continue to under report a portion of their 3G/4G device sales. Having robust and active compliance programs in place, the company is taking the relevant steps to address this issue. Until the issue is fixed, this will negatively impact Qualcomm’s licensing revenue. (Read: Qualcomm Lowers Its Licensing Outlook For Fiscal 2014)
Growth of 3G/4G LTE Wireless Technologies In Emerging Markets To Drive Growth; China LTE Transition Offers The Biggest Opportunity
Qualcomm 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. Growth in the quarter was primarily driven by broad-based demand for Qualcomm’s 3G and multimode 3G/4G chipsets 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 earlier this year, 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.
Qualcomm claims that its success to-date in China is based on chipsets that were launched last year. The commercialization of its new low cost architecture with the Snapdragon 410 will raise the competitive benchmark and improve product costs.
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