Earnings model for QUALCOMM supports our strong buy rating
A research paper issued on 10/20 by Pete Peterson et al. of Prudential Volpe.
Warning: very long but thorough. (Article somewhat abbreviated due to length but not edited.)
(415) 274-7983 pete_peterson@pruvolpe.com
Summary: A closer look at our earnings model for QUALCOMM supports our strong buy rating
* Shares of QCOM have seen significant near-term upside recently as news flow from China indicates progress for CDMA.
* We are breaking out all of the assumptions in our multi-variable model in order to highlight that QUALCOMM should see upside over the next 12 months.
* Based on our assumptions we believe QUALCOMM should see a 5-year EPS CAGR of approximately 40%.
* The company currently trades at 75 x our forward four quarters EPS estimate of $1.03 yielding a P/E to growth (PEG) ratio of 1.9, a ratio we believe is too low for a high-growth name with strong proprietary technology.
* QUALCOMM is in the enviable position of winning either way when carriers make their 3G technology decision between CDMA2000 and W-CDMA.
* The company's planned spin-off of its chipset business could further unlock value for shareholders.
* According, we reiterate our Strong Buy rating on shares of QCOM.
We are detailing our model to illustrate the EPS growth opportunities
....The stock has seen pressure over the first half of this year owing to extreme valuations, setbacks in the Korean market in relation to handset subsidies, and the delay in CDMA implementation in China. There is a great deal of discordance in the marketplace over QUALCOMM but we believe that our model justifies our Strong Buy rating and are detailing each of these assumptions inn our model. We believe that when viewed in its entirely, QUALCOMM's story is still compelling and warrants a Strong Buy rating at these levels.
<Investment thesis - QUALCOMM is among the best-positioned
companies in the wireless market
Qualcomm is the creator and owner of the rights to CDMA,
the most advanced digital wireless telephony technology now
available. CDMA is the fastest-growing wireless digital
standard in the world, competing with GSM technology or
global telephony network deployments. QUALCOMM benefits
from CDMA growth through product sales as well as through
licensing and royalty fees from any CDMA product sold by a
licensee. We estimate that QUALCOMM has in excess of 90% of
the CDMA chipset market and is one the best-positioned
companies for the W-CDMA chipset market. The company also
has additional revenue opportunities in the power control,
vodec, voice recognition, and location markets. CDMA is
considered the best digital wireless technology in terms of
capacity, sound quality, and data throughput. CDMA is also
the most prevalent digital technology in the US and is
gaining momentum around the world, posting approximately 71
million subscribers as of July 2000.
CDMA subscriber/unit growth drives the QUALCOMM story
IX transition should accelerate replacement rates for
cdmaOne/2000 in near term
...We are conservative in our cdmaONE projections as a
result of Korean handset subsidies and Chinese deployment
issues, but we are still modeling strong unit growth
opportunities in North America, South America, and Japan.
In addition, QUALCOMM plans to compete in the W-CDMA
chipset market and we believe the company will likely be
one of the market leaders. Our subscribers and unit
assumptions, which are based on QUALCOMM's September fiscal
year-end, are as follows:
F00E F01E F02E F03E F04E F05E
cdmaOne/2000 cum subs 72 110 160 231 324 421
cdmaOne/2000 Replacemt 40% 50% 55% 60% 60% 65%
rate*
cdmaOne/2000 phone unit 48 73 111 155 231 304
sales
W-CDMA cum subs 10 54 150 250
W-CDMA phone replacemt 5% 15% 35% 40%
rate
W-CDMA phone unit 15 48 125 169
sales
_________
Source: EMC, Dataquest, and Prudential Volpe Technology Group
We estimate that QUALCOMM enjoys an approximately 90%
market share in CDMA chipsets in the most recent quarter
owing in part to the company's proprietary position.
QUALCOMM should lose some of this market share as Nokia
strengthens its CDMA product offering; however, we believe
the company should maintain a dominant position thanks to
strong relationships with other handset OEMs and the coming
transition to IX technology. We believe QUALCOMM has at
least a 6 month lead in third-generation cdma2000
technology. The company will have significant competition
for W=CDMA chipset but should still be a market leader
thanks to a strong technology portfolio and relationships
with many second- and third-tier handset OEMs. We are
modeling between 25%-40% market share for W-CDMA chipsets.
Our ASIC assumptions, which are based on QUALCOMM's
September fiscal year-end, are as follows:
(Table ommited here due to its size and complexity
If interest, however, I could provide specific numbers.)
Licensing and royalty appear intact
QUALCOMM has a strong patent portfolio that should allow
company to maintain its royalty rate for W-CDMA near the
levels achieved for CDMA. There is a great deal of debate
over this single issue in the investment community but we
believe that the company is correct in its repeated
confirmations that it will receive the same rates. We also
believe that the recent decision to spin off its SIC
business could further strengthen QUALCOMM's intellectual
property position by separating the royalty business into a
separate unit; however we still need to see further details
on the royalty relationships over the next several months.
The company's strong royalty position is one of the main
reasons why QUALCOMM is now 3G agnostic, because it
believes that it will receive payments, which are
essentially pure profit, whether a carrier chooses cdma2000
or W-CDMA. Our royalty assumptions, which are based on
QUALCOMM's September fiscal year-end, are as follows:
----------------------------------------------------
F00E F01E F02E F03E F04E F05E
ASP,CDMA phone $ 210 179 152 140 135 130
Royalty rate cdmaOne % 4.5 4.5 4.5 4.5 4.5 4.5
/2000
cdmaOne/2000 handset $ 602 672 862 1095 1393 1666
royalty rev(M)
---------------
ASP, W-CDMA phone $ 350 300 260 210
Royalty rate W-CDMA % 4.0 4.0 4.0 4.0
W-CDMA handset $ 212 574 1303 1418
royalty rev (M)
---------------
Infrastructure royal. $ 86 90 140 160 80 40
---------------
License and Royalty $
SUMMARY
One-time license rev 30 30 30 30 30
(M)
QTL: Licenses 681 800 1245 1829 2775 3124
(Lic. Dev. Rev)
Impact of China on our numbers
As we stated earlier this year, we believe that a CDMA
network will be a reality in China, but the timing is still
unclear and the impact of this new CDMA network on QUALCOMM
of this new CDMA network on QUALCOMM's earnings is
uncertain. We are assuming a conservative ramp of 1 million
subscribers in fsical year 2001, 5 million subscribers in
fiscal year 2002, 15 million subscribers in fiscal year
2003, 25 million in fiscal year 2004 and 35 million
subscribers in fiscal year 2005. These cumulative
subscriber additions would increase the EPS growth rate to
42.5% from 42%. This subscriber ramp could prove to be
conservative based on the low penetratioon and huge market
that China represents. At this time, however, we believe it
is prudent not to include these subscriber estimates but
point to their potential as an opportunity going forward.
Based on our assumptions, it appears QUALCOMM trades at a discount
Based on First Call numbers and our estimates, QUALCOMM
trades at a discount to both the large-cap wireless names
as well as many of the wireless semiconductor com panies.
Qualcomm's calender year 2001 P/E of 58 times is above the
average calender year 2001 P/E of 41 times for the large-
cap names and 38 times of the ratio semiconductor
companies. But when we based the com parison on a P/E to
growth ratio, QUALCOMM's 1.48 is below the average of 1.63.
In addition, we believe that if China adopts CDMA, there is
opportunity for the growth rate of 40% to increase.
The sum of parts valuation also indicates upside for the
stock
The company announced in July that it planned an IPO of its
ASIC business, temporarily named Spinco, for the fall. We
broke out the two business into separate models in order to
determine its post split value. The two companies income
instatement summaries are as follows:
Cal yr C00 C01 C02 C03 C04
Current Qualcomm Rev (M) $2684 3832 5439 7865 10018
EPS $1.02 1.34 1.88 2.71 3.50
New Qualcomm Rev (M) $1451 1724 2350 3092 3918
(without Spinco) EPS $0.50 0.80 1.06 1.38 1.74
Spinco Rev (M) $1233 2110 3089 4773 6099
EPS $0.50 0.52 0.78 1.23 1.56
The new QUALCOMM valuation
We searched for some good comparables against which to value the two new companies. For the new Spinco, the spin-off of the ASIC business, we looked at other wireless integrated circuit companies. We believe Spnco should trade at the same valuation as an RF Micro Devices based on its market leading technology and exposure to high growth CDMA. Based on RFMD's P/E of 49 times calender 2001 earnings, SPinco would have a current share price of $25. We believe the best comps for the remaining QUALCOMM are intellectual property (IP) companies that license their developed technologies to integrated circuit or systems companies. The range of multiples is pretty extreme for this group. Arm Holdings at the high end develops IP for wireless equipment companies, which is very similar to the Spinco model; however, ARM's valuation appears to be a bit of an outlier. Rambus' valuation is more reasonable, in our view, and we believe that QUALCOMM should trade at a premium based on its exposure to high growth markets, but we are slightly discounting to 100 times 2001 earnings to be more prudent. Based on 100x our 2001 EPS estimate of $0.80, we believe this part of the business should be worth $80 per share. Thus a sum of the parts valuation yields a current share price of $105 based on our conservative estimates.
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