China Economic Uncertainty Looming Over Qualcomm

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Recent events and data suggest that Qualcomm (NASDAQ:QCOM) is presently struggling. The factors which have affected the company are a fall in earnings and a gloomy revenue outlook for the current fiscal year. It was for the second time that the chip maker reduced its forecast, as we noted in our last earnings review. Contributing to the diminished outlook was the exclusion of its application processor from Samsung’s new Galaxy S6 smartphone, due to the fact that the part (called the “Snapdragon 810) overheated during initial Samsung tests. On top of this, the hedge fund Jana Partners, having taken a $2 billion position in the company, has been pushing for the divestiture of the processor business, which we have also discussed. Now with tumbling markets and economic uncertainty in China, Qualcomm has become more vulnerable to major risks, as the company derives a big portion (~50%) of its sales from China, the world’s second-largest economy. [1]

In this article, we discuss how the slowing pace of China’s economic growth – in addition to China’s promotion of local competitors – could pose a threat to Qualcomm.

China witnessed a 30% slide in its stock market since mid-June, which raised investors’ concerns about the stability of the Chinese economy. China’s stock market tumble comes as the chip sector was already facing a tough year. Research firm Gartner had said earlier this year that it is downgrading its assessment of worldwide semiconductor sales, which it had initially expected to reach $354 billion this year, a 4 percent increase from 2014. Yet it has just reduced this forecast to $348 billion for a 2% increase, noting that the typical sequential increase into the second quarter has not occurred this year.

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The fact that China’s economy is slowing and its economic outlook is uncertain may induce lower consumer spending as individuals hold off on purchasing tech devices including new smart phones. If this were to happen, Qualcomm would continue to see reduced sales in China and the LTE rollout would weaken as we progress through this year. There is  the possibility that, for the next two quarters, Qualcomm could continue to face sluggishness in the shipment of its MSM chips.

Longer term, Qualcomm faces the prospect of heightened competition. Last year, China announced that it would invest 120 billion yuan to develop the domestic integrated circuit industry. The funds, which reportedly exceed the total investment in the industry over the previous decade, are designed to support domestic chip makers, increase localization and reduce reliance on imported chips. It is consistent with the goal mentioned about developing domestically produced equipment. We thus see that near-term and long-term uncertainly looms for the company, even as its strong global market position persists.

Our price estimate of $71 for Qualcomm is marginally higher than the current market price.

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Notes:
  1. China economic uncertainty a potential risk for U.S. chipmakers like Qualcomm Inc, Financial Express, July 7th, 2015 []