Qualcomm’s (NASDAQ:QCOM) stock has been pretty volatile of late. After the company released its Q2 results late last month, shares fell almost 7% as investors fretted over its lower-than-expected earnings guidance for the next quarter. Since then, the stock has moved up in line with the broader markets and recouped most of its losses. But if we look at the past three months’ performance, Qualcomm has underperformed the broader NASDAQ index. Since the end of February, Qualcomm has declined over 3% while NASDAQ is up about 10%.
A big reason for Qualcomm’s recent lackluster performance has been concerns over margins, which are showing signs of trending downward. With most of the future smartphone growth expected to come from the emerging markets, low-end smartphones will drive down the average selling prices (ASPs). This will not only have an impact on licensing revenues (which are based on handset ASPs), but also put pressure on chipset margins as the sales mix of low-margin chipsets increases. Last quarter’s chipset margins came in at 17%, down from the historical average of 20%.
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However, the company maintained its full year operating margin guidance for the chipset and licensing divisions, implying that the latter half of the year should pick up the slack as handset makers launch high-end smartphones in preparation for the holiday season. As a result, the company also expects ASP levels to hold firm for FY 2013 as compared to FY 2012 despite what looks like a slow start to the year. There also seems to be enough support to mobile ASPs in the near term, as new innovative features such as wireless charging, HD Wi-Fi and fingerprint-sensing hardware are added to high-end phones in the coming quarters.
In the longer term, however, there is likely to be pressure on margins and mobile device ASPs as the mix shifts towards emerging markets and LTE competition catches up. Keeping all these factors in view, we have a $70 price estimate for Qualcomm, about 10% ahead of the market.
ASP decline will impact high-margin licensing business
Most of the future smartphone volume growth is likely to come from emerging markets such as China and India as the wireless market in developed countries gets saturated and carriers there look to lengthen the smartphone upgrade cycle to lessen the subsidy impact. According to IDC, more than 210 million smartphones were sold in China last year giving the country a share of almost 30% of the world market and leaving the U.S. far behind. With a billion strong mobile subscriber base and carriers increasingly trying to transition their 2G base to 3G, China presents a huge opportunity for Qualcomm to not only gain from its chipset sales, but also earn a steady stream of licensing revenues. (see Qualcomm Introduces Three New Entry-Level Chipsets To Target Emerging Markets) However, an increasing mix of low-end mobile phones sold in the emerging markets will see mobile ASPs fall, limiting the upside to licensing fees from such a scenario.
We currently estimate that the 2G to 3G/4G transition will see 3G/4G penetration of mobile devices worldwide grow from about 50% currently to about 65% by the end of the forecast period. However, the increasing adoption of smartphones in the emerging markets buoyed by the growing number of low-end affordable smartphone options could see 3G/4G penetration increase to about 80% by the end of our forecast period. Such a scenario would add further 10% upside to our price estimate. However, if mobile ASPs fall to about $150 from the current level of $220 simultaneously due to the growing emerging market mix, the upside to our price estimate would be limited to only about 6%.
Qualcomm’s LTE Superiority Preserves High-end Dominance
As for 4G LTE, this high-speed technology is being widely promoted in the developed regions of the U.S., Japan and South Korea. Qualcomm has taken a big early lead in this market, having come to the market first with its LTE-capable baseband chipsets. Of the 47 million LTE-capable chipsets that were shipped last year, Qualcomm accounted for nearly 86%. This big lead is a testament to the company’s superiority in 3G/4G connectivity solutions which has helped it perform really well in the smartphone market so far.
As a result, while competitors are only now bringing their first LTE basebands to market, Qualcomm’s chipsets are in their third-generation already. Competition in the LTE market is growing with Samsung and Nvidia making their Exynos and Tegra line LTE-compatible, but we expect Qualcomm’s technological superiority to help it hold fort in the near term. This could be seen in Samsung’s decision to launch the Galaxy S4 with Qualcomm’s chipsets for LTE markets despite having a LTE-compatible chipset of its own. While Qualcomm’s huge initial market share is likely to decline over time due to increasing competition, the overall growth in the LTE market should help more than offset that impact going forward.