Qualcomm’s Earnings Preview: License Business Remains Uncertain But 3G/4G Continues To Be Strong

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Leading mobile chipmaker  Qualcomm (NASDAQ:QCOM) will report its Q1 2015 earnings on January 28th. For fiscal 2014 (ended September 2014), the company reported a 6.6% and 17.0% annual growth in revenue and non-GAAP earnings respectively. Though the company continued to see growth in the QCT segment (Qualcomm CDMA Technologies), driven by the rising penetration of 3G and 3G/4G multimode devices around the world, its QTL (Qualcomm Technology Licensing) segment faced challenges in China. China is a major source of growth for Qualcomm’s 3G/4G LTE chipsets. The company is facing a governmental (NRDC) investigation for alleged monopolistic practices in China, in addition to ongoing regulatory investigations in the U.S. and Europe.

Qualcomm expects to resolve the licensing issue in China soon, but remains uncertain of the timing. Accordingly, the company believes that the QTL revenue growth many be muted to some extent in fiscal 2015. Additionally, Qualcomm forecasts the global device ASP’s to decline during fiscal 2015 at a faster pace than recent years, but still expects a reasonable growth in its 3G/4G device sales driven by very strong unit growth. It claims that the growth in global 3G/4G device demand remains strong, which along with new emerging opportunities, will drive its long-term growth.

For fiscal 2015, Qualcomm anticipates revenue in the range of $26.8 billion to $28.8 billion (up 1% to 9% year on year). The company expects its QCT  and QTL revenue to be up 6% and 3% year on year, respectively, at the midpoint of the guided range. For Q1 2015, Qualcomm’s revenue target is between $6.6 billion to $7.2 billion, up 4% year on year at the midpoint.

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Our price estimate of $74 for Qualcomm is in line with the current market price. We will update our valuation after the Q1 2015 earnings release.

See our complete analysis for Qualcomm stock here

Qualcomm’s 3G/4G Business To Grow In 2015 Despite Accelerating ASP Decline

In its Q4 2014 earnings call, Qualcomm admitted that the global demand for 3G/4G devices continues to grow at a very healthy pace, particularly in the emerging regions at mid and low price tiers. The broad availability of compelling devices at these price points is driving demand for, and the migration to, 3G/4G devices. The biggest opportunity for Qualcomm in China is China Mobile, which is transitioning from its TD-SCDMA standard to TD-LTE. In addition to China, Qualcomm claims to be seeing strength in its 3G portfolio in other markets such as Latin America.

Several factors primarily related to Qualcomm’s challenges in China are creating a divergence between Qualcomm’s estimates of the global 3G/4G device and what is being reported to the company. According to Qualcomm, some of its Chinese licensees are under reporting sales and may continue to under report a portion of their 3G/4G device sales in the future. During Q4 2014, approximately 258 million 3G/4G devices were reported to Qualcomm. For calendar year 2014, the company estimates that the reported 3G/4G devices will be in the range of 1.04 billion to 1.13 billion units, which is approximately 215 million units below the global 3G/4G device estimate of approximately 1.3 billion units at the midpoint. For 2015, Qualcomm forecasts global 3G/4G device shipments to be approximately 1.5 billion units, up approximately 15% year-on- year.

In fiscal 2014, the Average Selling Price (ASP ) of 3G/4G devices reported to Qualcomm stood at $225, approximately 6% higher than it would have been if the full global 3G/4G device demand had been reported to it. The decline in 3G/4G device ASPs in fiscal 2014 was more than what the company had expected at the onset of the year, driven by accelerated migration from GSM and TD-SCDMA devices to low and mid-priced 3G/4G smartphones in emerging regions. Increasing competition at the premium and high tiers, along with an increased mix of lower-priced handsets in emerging regions, has put a downward pressure on device ASPs.

Qualcomm estimates the global 3G/4G ASP will decline by approximately 9% to 10% in fiscal 2015. Beyond fiscal 2015, the company expects to see the decline in the 3G/4G global ASPs to moderate as the weighted impact of the factors that are driving the near term declines in ASPs ease, and users in emerging regions trade up in replacing their low tier devices.

As price elasticity drives strong unit growth at lower tiers, Qualcomm estimates the total dollar amount of global 3G device sales to have grown by approximately 10% in fiscal 2014, despite the approximate 6% ASP decline. The company forecast approximately 7% to 8% year-on-year growth of such sales in fiscal 2015.

Uncertainty Around The Licensing Business

Qualcomm’s licensing business is suffering on account of a dispute with Qualcomm licensees, under reporting by certain licensees, and sales of certain unlicensed devices in the region. Given the difficulty in predicting the timing and impact of resolving the challenges in China, Qualcomm’s QTL guidance for fiscal 2015 incorporates a wide range of potential outcomes. It expects QTL revenue in the range of $7.3 billion to $8.3 billion. The lower end of the guidance assumes no material resolution of the licensing issues in China, whereas the high end of the range reflects more favorable outcomes with respect to several of the issues.

Below are the key issues that limit Qualcomm’s licensing growth potential in the near future:

1. Dispute with a licensee: Qualcomm is undergoing dispute with one of its licensees, which resulted in the non-exclusion of a portion of that licensee shipment in the last two quarters. The company claims that it is still undergoing active discussions with the licensee.

2. Unlicensed three mode activity in China: 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. China Mobile is transitioning from its TD-SCDMA standard to TD-LTE. The company has signed more than 75 single-mode LTE licenses with Chinese OEMs, but OEMs supplying a meaningful percentage of three-mode devices remain unlicensed. Though the company is in discussions with many of these OEMs, the negotiations have been delayed on account of the pending NDRC investigation.

3. Negotiating licenses with new potential licensees: Qualcomm has witnessed an increase in sales of lower tier 3G connected tablets by a number of Chinese OEMs. It expects sales of these devices to grow in the future, which is beneficial for 3G/4G attach rates and tablets. However, the tablet OEMs are mostly not the same companies that have been supplying the handsets in China, and therefore in most cases, are not currently licensed. Though Qualcomm is continuing to pursue licenses with this new base of potential licensees, the company claims that the discussions will take some time to complete, and the timing may be impacted to some extent by the pending NDRC investigation.

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