DBAB raising target to $140: QCOM: HOW DO YOU VALUE QUALCOMM?--STRONG BUY
Deutsche Banc Alex. Brown - US Equities
Brian T. Modoff,Ian W. Toll
June 16, 1999
---------------------------------------------------------------------------
----
QUALCOMM INCORPORATED [QCOM] "STRONG BUY"
How Do You Value Qualcomm?
---------------------------------------------------------------------------
----
Date: 06/15/1999 EPS 1998A 1999E 2000E
Price: 113.37 1Q 0.29 0.33 0.72
52-Wk Range: 120 - 19 2Q 0.13 0.41A 0.61
Ann Dividend: 0.0 3Q 0.17 0.61 0.70
Ann Div Yld: 0.00% 4Q 0.33 0.64 0.69
Mkt Cap (mm): 16,393 FY(Sep.) 0.91 1.99 2.70
3-Yr Growth: 20% FY P/EPS NM 57.X 42.X
CY EPS 0.95 2.38 2.75
Est. Changed Yes CY P/EPS NM 47.6X 41.2X
---------------------------------------------------------------------------
----
Industry: COMMUNICATIONS TECHNOLOGY
Shares Outstanding(Mil.): 144.6
Return On Equity (1998) : 25.0%
---------------------------------------------------------------------------
----
HIGHLIGHTS:
--Since Qualcomm announced the sale of its CDMA infrastructure business,
investors have been reevaluating how to value this company.
--Our approach is to break the company down to its major segments and
value these individually
--In the process of evaluating the various sectors, calculating their
earnings power and factoring in the p/e multiples of comparable
companies lead us to an overall valuation of $140 per share.
--Bottom line, royalty revenues drive this company's market valuation.
However, R&D developments in other segments (particularly in ASICs) are
what drive future royalty streams.
--Recent channel checks indicate that current demand for CDMA chipsets,
handsets and infrastructure is strong, driven by subscriber growth in
Japan, the US and Latin America.
--We have made adjustments to our earnings model to factor in higher
revenues due to increased industry shipments of CDMA handsets and
infrastructure and increased share count due to the conversion of
preferred shares to common stock in 2Q/00.
--We are comfortable with our 3Q revenue and earnings estimates of $1
billion and $0.61. We reiterate our strong buy rating and are raising
our 6-12 month price target to $140.
DETAILS:
Since Qualcomm announced the sale of its CDMA infrastructure business,
investors have been reevaluating how to value this company. Our approach
is to break the company down to its major components and value these
individually, keeping in mind the influence these segments have on the
overall growth of the company. The conclusion is that, based on our
current estimates, Qualcomm's shares are fairly valued at $140 per share.
The following is a discussion of each segment.
Handsets
The CDMA handset business is growing very rapidly, despite the near-term
(and short term) hiccup in Korea. For FY99, we are forecasting that 38.1
million CDMA handsets will be shipped worldwide (generating $9.1 billion in
revenues), up from 20.8 million units ($6.7 billion in revenue) in 1998.
For 2000, we are forecasting that these shipments grow to 57.5 million
units ($12.1 billion). By 2003, we forecast that 132.5 million units will
be sold generating $22 billion in revenues. Our five-year growth
projection for CDMA handsets is 45% unit growth and 27% revenue growth.
Both of these projections are above our overall industry handset unit and
revenue forecasts.
In 1998, Qualcomm sold approximately 4.8 million handsets and generated
$1.6 billion in revenues. Due to low margins, we estimate that the company
lost approximately $0.39 per share in 1998 in its handset business. For
1999 and 2000, we are forecasting Qualcomm's handset units, revenue and
fully-taxed earnings at 7.82 million units, $1.95 billion and $0.09 per
share and 10.33 million units, $2.16 billion and $0.50 per share.
Valuation: Wireless handset vendors are currently trading at multiples of
between 25x and 35x FY00 consensus estimates. Qualcomm management insists
that the company will remain a player in the CDMA handset market and that
the company can remain competitive despite the large volume advantages of
the larger players. We agree that the thin phone is a solid new product
for the company. Still, in our opinion, the company's track record of
profitability in this division limits the multiple our FY00 earnings should
receive. Assigning a low end of the range multiple of 25x on our FY00
earnings of $0.50 values this division at $12.50.
Long term, we believe that the handset business may be a tough business for
a company Qualcomm's size to compete in profitably. We think that this
product line will eventually be sold. Given that a sale of the handset
business would eliminate some earnings risk to the stock, we believe that
any earnings reduction made as a result of this sale would be more than
offset by a earnings multiple expansion.
CDMA ASICs
The CDMA handset ASIC market is growing rapidly, in response to both CDMA
handset unit growth and demand from multiple vendors seeking a percentage
of the CDMA handset market. In 1998, approximately 21 million CDMA handset
ASICs were sold, generating over $600 million in revenues. This year, we
are forecasting that over 39 million units will be sold, generating $950
million in revenues. Next year, our forecast is almost 60 million units
and $1.3 billion of revenues. In 2003, we anticipate that 150 million CDMA
handset ASICs will be sold, generating $2.6 billion in revenues. Our five
year unit and revenue growth forecasts are 48% and 34% respectively.
Qualcomm dominates the CDMA ASIC business with a market share of around
90%. Further, given the company's R&D efforts in CDMA technology for
second and third generation applications, we anticipate that Qualcomm will
continue to maintain a large market share. The CDMA ASIC business is a
very profitable business for Qualcomm, generating a gross margin of at
least 45%. Still, with Nokia (who uses their own chipset) and Motorola
(who uses their own chipset in most of their phones and a Qualcomm chipset
in the SC3160) ramping volume production and Samsung (Qualcomm's largest
customer) likely to use its own chipset in a low end phone scheduled for
sometime next year, we believe that Qualcomm's market share will decline to
45% by 4Q FY00.
The CDMA infrastructure ASIC market is also an attractive business,
although much smaller than the market for handset ASICs. In 1998, the
infrastructure ASIC market was $132 million in revenues. We are
forecasting that this market will grow to around $435 million by 2003 for a
CAGR of 27%. Qualcomm's market share is around 65%. Competition in this
market is limited. We are forecasting that Qualcomm's market share
declines modestly over this five year time frame (to around 57.5%).
Valuation: Due to strong revenue growth, small to mid-sized communications
chipset vendors are currently trading at healthy multiples in the range of
40x to 60x FY00 consensus earnings estimates. Our earnings model assumes
that Qualcomm's handset ASIC unit market share declines from over 90% in
the current quarter (3Q) to 80% in 4Q (averaging 87% for FY99) and exits
FY00 at 45% (averaging 55% for FY00). We believe that Qualcomm will need
to capture one of the top three handset vendors in order to achieve our
market share assumptions (Ericsson is the likely candidate).
Qualcomm is currently seeing very strong demand for their CDMA handset
ASICs primarily from Korean and Japanese handset vendors. In 1999, we are
forecasting 57% ASIC revenue growth to $751 million and fully taxed
earnings of $0.70. However, due to our more aggressive market share loss
assumptions (management believes that they can maintain a market share of
60% to 70%) our ASIC revenues actually decline in 2000 from 1999 to $643
million and an EPS of $0.57. Revenue growth returns beyond 2000 as
Qualcomm's market share stabilizes at around 40%. Because of our lower
revenue growth assumptions versus other communications chipset vendors,
offset somewhat by the size and growth of the overall CDMA ASIC market, we
are assigning a multiple of 40x our conservative FY00 EPS estimate of
$0.56. This multiple would value the CDMA ASIC segment at $22.40 per
share.
Royalties and License Fees
Qualcomm collects royalties on every non-Qualcomm IS-95 CDMA handset, base
station and ASIC (except those used internally by Nokia and Motorola) sold.
This royalty payment ranges between 2% and 5% of the cost of the CDMA
portion of the product sold (for handsets and ASICs its 100% of the sale
price, for base stations it the portion of the product that's CDMA
enabled). In addition, the company collects one-time license fees from
vendors wishing to manufacture IS-95 CDMA enabled products. In 1998, these
agreements generated $214 million in revenues for Qualcomm ($0.94 in fully-
taxed earnings). In 1999 and 2000, we are forecasting royalty revenues and
fully-taxed earnings of $285 million and $1.17 and $424 million and $1.45.
Our five year forecast for IS-95 CDMA royalty revenue growth is 36% ($995
million in FY03).
The deal that Qualcomm struck with Ericsson is positive for Qualcomm
because it allows Qualcomm to collect royalties from other vendors for
WCDMA as well. We note, however, that these royalties have yet to be
negotiated with the various vendors (Philips is the exception) wishing to
produce equipment for third generation CDMA equipment. Some of these
vendors, such as Nokia, have certain WCDMA patents that they will use as
leverage in negotiating agreements. Further, the royalty fees, as a
percentage of the cost of the product, are likely to be lower than the
current IS-95 agreements (between 1 and 2%). However, the addressable
market for license fees grows from 25% of the market (for IS-95 CDMA) to
80% of the market (for both IS-95 CDMA and WCDMA). We anticipate that
these negotiations will occur within the next two years and will be
factored into our estimates for 2001 or 2002.
Valuation: Because royalty based earnings streams are viewed as more
predictable than those derived from hardware sales, the multiples these
companies command are often much higher than those of hardware vendors
supplying products into the same market. Royalty based technology
companies such as Rambus, ARM and MIPS currently trade in a broad range of
valuations from 35x (MIPS) to 110x (ARMHY) the FY00 consensus earnings
estimates. The current group average is 70x FY00 consensus estimates.
Further, this group's average multiple has traded between a low of 50x to a
high of 129x the FY00 consensus earnings estimates.
Qualcomm is similar to the above royalty based companies because the
company possesses core technology for a dominant emerging technology -
CDMA. Given Qualcomm's deep understanding of CDMA technology and its
continued efforts to expand and enhance CDMA's capabilities, we believe
that the company will be in a position of monetize its design efforts for
the next several years. Further, CDMA is currently experiencing strong
unit growth and is likely to receive an additional boost as WCDMA networks
get deployed starting in 2001. Using the above group's average multiple of
70x FY00 earnings would imply a valuation for Qualcomm's royalty segment of
$101.50.
Other Businesses
Qualcomm's remaining business include Omnitracs, Eudora and engineering
contracts. Cumulatively, we are forecasting that these businesses will
generate $647 million in revenues and $0.20 in earnings in FY00. A
conservative multiple of 20x these earnings would imply a valuation of
$4.00 for the remainder of Qualcomm's business.
We note that because we do not possess a detailed breakdown of the costs
incurred by each division our fully-taxed EPS assumptions are
approximations only. Consequently, valuing the "other businesses" on
something other than earnings would be more accurate.
Conclusion
Factoring in the valuations of Qualcomm's various business segments leads
to a valuation of $140 per share. Clearly royalty revenues drive this
assessment. However, R&D developments in other segments (particularly in
ASICs) are what drive future royalty streams. As a strong IP company,
Qualcomm should command a multiple similar to its peer group, in our
opinion. Further, should Qualcomm sell its handset division the company's
multiple would likely expand further as a premier supplier (with better
earnings visibility) of communications chipsets and technology.
Recent channel checks indicate that current demand for CDMA chipsets,
handsets and infrastructure is strong, driven by subscriber growth in
Japan, the US and Latin America. Recent large contract awards for CDMA
handsets and infrastructure support this assessment. We have made
adjustments to our earnings model to factor in higher industry shipments of
CDMA handsets and infrastructure. In addition, we have adjusted our
Qualcomm earnings model to reflect higher shares outstanding from the
conversion of preferred shares to common stock in 2Q/00 (adding 18.2
million shares). We are comfortable with our modestly increased 3Q revenue
and earnings estimates of $1 billion and $0.61 ($0.22 including charges).
We reiterate our strong buy rating and are raising our price target to
$140.
|
