Qualcomm Earnings: Recently Concluded Licensing Agreements And Higher Device ASPs Help Post A Strong Quarter

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Leading wireless technology developer Qualcomm  (NASDAQ:QCOM) posted strong results for fiscal Q1 2016 on January 27th. (Fiscal years end with September.)  Catch up payments from its licensees in China, higher device average selling price (ASPs) and increases in device units sold by Qualcomm’s customers all helped the company beat consensus estimates. However, a contract dispute with LG reduced Qualcomm’s revenue by as much as $100 million. Going ahead, litigation issues and underreporting of sales in China will continue to impact the company’s performance. Although Qualcomm is quickly closing the gap in China, according to the company’s management, there are still a handful of OEMs in the region that are not complying with the licensing agreements.

Nevertheless, the company is trying to expand its reach into other adjacent high growth segments including advanced processors for servers, IoT (Internet of Things) devices and drones. Also, Qualcomm has had more than 100 design wins for its upcoming flagship chipset Snapdragon 820, which can gain further traction in 2016. We believe that the aforementioned factors can offset the decline from litigation issues as Qualcomm’s investment in these areas start to pay off.

Our price estimate of $60 for Qualcomm is approximately 27% above the current market price. We are in the process of updating our model for the Q1 2016 earnings.

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See our complete analysis for Qualcomm stock here

Quick Snapshot of the Q1 2016 Earnings

Qualcomm’s Q1 2016 revenue ($5.8 billion) and non-GAAP earnings ($0.97) were both above its expectations. With 242 million MSM chipsets shipped in Q1, the company’s QCT (Qualcomm CDMA Technologies) revenue stood at $4.1 billion and remained in line with its expectations. The operating margin for the segment stood at 14%, reflecting a stronger than expected demand in the low tier segment in China. In QTL (Qualcomm Technology Licensing), recent licensing deals and higher than expected ASPs and unit shipments led to stronger revenues at $1.6 billion. The total reported device sales by Qualcomm licensees were $60.6 billion. (Read the earnings release here)

Licensing Agreements In China Based On New NDRC Terms Fast Progressing

Qualcomm claims to be fast progressing in concluding the licensing agreements with Chinese OEMS based on the new licensing terms set by NDRC (National Development And Reform Commission) of China in 2015. Some of the deals bagged by the company in the recently concluded quarter were with Xiaomi, Haier, QiKu and Tianyu Sign. [1]. The catch up payments received by concluding these agreements helped Qualcomm beat its QTL (Qualcomm Technology Licensing) revenue estimates in Q1.

However, the underlying difference between the actual device sales and reported device sales to Qualcomm was as large as $25 billion in 2015, which weighed heavily on QTL revenues throughout the year. Furthermore, there are still a handful of OEMs in China that are not complying with the licensing agreements, which can result in lower licensing revenue for the company going forward. Nevertheless, the company’s plan to take action against those OEMs who continue to underreport sales or refuse to conclude new licensing agreements can improve compliance in the region.

In February 2015, Qualcomm agreed on a settlement with the government of China pertaining to the royalties it charges to licensees in the market. The company paid litigation charges of $975 million to settle regulatory investigation by China’s National Development and Reforms Commission (NDRC) for alleged monopolistic practices in the region. However, slow progress by Qualcomm in implementing the NDRC licensing terms and non-compliance by Chinese OEMs of these term affected the company’s licensing profits in 2015. Nevertheless, Qualcomm is making significant progress in solving the compliance issues in China and we believe that the company can soon be over the hump in the large smartphone market.

Qualcomm Can See Gains From Its Premium Chipset Snapdragon 820 In The Second Half Of 2016

Qualcomm faced a huge setback in 2015 as its flagship processor Snapdragon 810 was dropped from the Samsung’s premium smartphone, the Galaxy S6, due to overheating issues. However, Qualcomm’s Snapdragon 820 Chipset, which is set to be launched in early 2016, can change the company’s fortunes. According to GSMArena, Snapdragon 820 chipset fares much better in terms of performance and other specifications compared to its predecessor.

Qualcomm has already announced the commercial debut of Snapdragon 820 in one Chinese company, Letv’s smartphone in the Consumer Electronics Show (CES) at Las Vegas.  Although Qualcomm is said to have significant design wins for Snapdragon 820 chipset to date,  the company expects to see more significant gains from its flagship chipset in the second half of FY 2016, when it enters mass production and commercialization. Furthermore, there have been rumors that Qualcomm can find its way into the Samsung’s upcoming premium smartphone, the Galaxy S7. Given that Samsung has the largest market share in smartphones, Qualcomm will be a clear beneficiary if these rumors prove to be true. And given the high selling price of the phone, it could be an even bigger win, as the company charges royalties as a percentage of device sales price. This will also help rebuild confidence in Qualcomm’s Snapdragon chipsets, after the failure of Snapdragon 810 due to overheating issues.

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Notes:
  1. Press release, Qualcomm, December 2015 []