Why We’re Revising Our Price Estimate For Qualcomm To $65?

We recently increased our price estimate for Qualcomm (NYSE:QCOM) by approximately 20%, to $65 per share. The revision in our price estimate for Qualcomm is mainly because we believe that the company will manage to maintain a higher royalty rate than what we previously anticipated for in our model. We fine tuned our model in other ways, lowering both the effective tax rates and operating expenses and increasing mobile chipset pricing. Below we detail the key reasons as to why we increased our price estimates:

A) Upward Revision In The Royalty Rate: Qualcomm was accused of monopolistic practices by the NDRC of China and had to pay $975 million and lower its royalty rates in the region as a result of the settlement in 2015. However, slow progress by Qualcomm in implementing the NDRC licensing terms, and non-compliance by Chinese OEMs of these terms, have affected the company’s licensing profits since then. For this reason, we believed that the company’s royalty rate might decline in 2016.

However, taking into account the progress made by Qualcomm to solve the problem of under-reporting in China, over the last two-three quarters, we have slightly increased our estimated royalty rate for the company in the calendar year 2016 and for the next couple of years. It should be noted that the company has signed deals with nine out of the ten largest OEMs in China and is in negotiation with another major player in the region. The latest of these deals are with Chinese smartphone giants Vivo and Oppo. Going forward, the company also expects to reach an agreement with the Alibaba-backed Chinese smartphone maker, Miezu Technology, after the settlement of the lawsuit against it.

B) Higher Mobile Chipset Prices: With the strong adoption of Qualcomm’s premium smartphone chipset, Snapdragon 820, in more than 150 smartphone designs, the average selling price of the company’s chipsets has improved from an estimated $16.90 in Dec’15 to $19.50 in Sept’16. Furthermore, the company claims that it is seeing strong adoption of its modem in adjacent businesses too. For this reason, we have also increased the revenue forecasts for the third segment of Qualcomm, which is clubbed with non-reportable segments by the company, and we have termed it as “Other Initiatives”. It should be noted that Qualcomm is leveraging its existing technical and business expertise to vertically expand its business into other high growth areas, apart from its core business. Going ahead, the company will also power Google’s much-awaited Pixel phones with the Snapdragon 821 chipset, which should further positively impact the average selling price of Qualcomm’s chipsets.

C) Reduced Effective Tax Rate: Seeing the steep increase of 5 percentage points in the effective tax rate for Qualcomm in between the calendar years of 2014 and 2015, we initially believed that the tax rate for Qualcomm is likely to further increase in 2016, and advance in the direction of the corporate tax rate in the U.S.. However, now that the results of three out of four quarters for the calendar year 2016 are out, it seems unlikely that the effective tax rate for the company will increase. Instead, we have now revised our forecasts to reflect a decline in the effective tax rate for Qualcomm in 2016. However, over the long run, we still hold that the company’s tax rate will gradually reach the corporate tax rate in the U.S.

D) Reduced Operating Expenditures:  In FY’16, Qualcomm has been successful in cutting down costs and meeting its ambitious targets for the year. The company reduced its costs by $1.4 billion in the year. The company exited the fiscal year with an operating margin of 16.6% in the QCT segment. Due to the successful execution of Qualcomm’s cost-cutting measures, we revised our forecasts for its operating expenses to reflect a decline in the metric for the year 2016, which further contributed to an increase in our price estimate for the company.

In the table below we present the key metrics that we revised for the company, which resulted in a higher estimate for Qualcomm’s stock price than our previous estimates:

Note: The above metrics are estimated for calendar year 2016

We are in the process of updating our model for Qualcomm.

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