re: Morningstar's Todd Bernier on Qualcomm (01-14-02)
In my previous post Todd Bernier looks at Nokia (one month ago)
>> Morningstar's Take on Qualcomm
01-14-02
Todd Bernier
Morningstar.com
morningstar.com
Plain and simple, Qualcomm is overvalued.
The September quarter was solid, as pro forma sales grew 6% from last year's period. Driving the growth was an improvement in the chipmaking business, a segment that has suffered mightily in the tech downturn. Qualcomm shipped 13 million phone chips in the timeframe, of which 4 million were third generation (3G) chips. Qualcomm has taken the early lead in 3G chips and is the de facto standard.
As usual, however, it was a messy quarter. An accounting change and lower interest income--the firm failed to accrue interest on a loan made to a Mexican wireless carrier--caused Qualcomm to miss First Call earnings estimates for the quarter. But the EPS shortfall is irrelevant to us. Rather, Qualcomm's nebulous pro forma book-keeping and, more important, lofty valuation is what gives us heartburn.
We feel that Qualcomm isn't worth $33 billion, its current capitalization (net of cash). At this price, Qualcomm trades at 12 times sales and 42 times earnings on a trailing basis. To be fair, backwards-looking metrics won't account for Qualcomm's future gains, projected by the analyst community to be huge. Instead we prefer to estimate the growth of cash flow.
The central point of our 10-year cash flow model is that sales growth will crank up as wireless carriers migrate to 3G. On the strength of its extensive patent portfolio, Qualcomm has signed license agreements with nearly every major manufacturer of 3G gear. More important, such agreements ensure that Qualcomm will receive a royalty check whichever 3G flavor is adopted, either Qualcomm's cdma2000 or the rival W-CDMA. We assume that within 5 years all phones will be embedded with some form of CDMA technology, and that Qualcomm's sales will reach $9.7 billion in the tenth year.
Our fair-value target of $39 is well below the stock's current price, which is precisely our point: even under the sunniest skies, Qualcomm is inflated. Even though our model assumptions are possibly too optimistic already, we'd have to use pie-in-the-sky parameters to justify Qualcomm's valuation. For example, we could lower the firm's cost of capital to just 10%, which would be below the long-term return on the S&P 500 Index, but we think Qualcomm is a substantially riskier bet than the index. Or we could raise Qualcomm's compounded annual growth rate to over 22%, which would translate into sales of $20 billion in year 10--again, unrealistic.
Strategy
Qualcomm focuses exclusively on designing the chipsets and system software that go into CDMA products. Also, Qualcomm invests in companies that will spread the use of CDMA products, on which the company earns a royalty (thanks to an extensive patent portfolio).
Management
Chairman, CEO, and founder Irwin Jacobs owns 3.5% of the firm; the executive suite has other members of the Jacobs' family. Richard Sulpizio recently resigned as president and COO, and was replaced by Anthony Thornley (the CFO).
Profile
Qualcomm pioneered Code Division Multiple Access (CDMA) technology, a digital platform used in cellular phones, telecom equipment, and satellite base stations. As a result, Qualcomm is the world's leading designer and supplier of CDMA chipsets and system software; it licenses CDMA technology to more than 100 various device makers. Also, the company's OmniTRACS systems provide satellite communications, position location, and location management for trucking fleets.
Close Competitors TTM Sales ($Mil) Market Cap ($Mil)
Qualcomm 2,680 36,042
Nokia ADR 28,291 101,349
Texas Instruments 9,446 46,925
Motorola 32,744 31,583
Valuation
The stock is expensive at 42 times First Call's 2002 fiscal year (September) estimate. We consider this to be an inflated price to pay for a firm whose bottom-line growth is anemic. The firm trades well above our intrinsic value calculation.
Growth Grade: D
Pro forma sales grew 6% in the September quarter from a year ago, driven by big gains in the chipmaking segment. Sales are projected to grow between 15% and 25% this fiscal year (ending September 2002).
Profitability Grade: B-
Profits are skewed by scores of "one-time" charges, which makes it difficult to determine how well Qualcomm is doing. However, EPS estimates for this year are just $1.10 (First Call)--only slightly better than fiscal 2001.
Financial Health Grade: A+
With about $2.6 billion in cash and no debt, Qualcomm's balance sheet is rock-solid. As pure-profit royalties (which require little additional capital spending) become a bigger portion of sales, free cash flow will accelerate.
Morningstar Risk: Medium
Stock Price As of 01-14-02 $47.15
Morningstar Fair Value $39.00
Bulls Say
* Qualcomm has many patents relating to CDMA (code-division multiple access) technology; any handset maker licensing even one patent must pay a flat royalty rate. Also, royalty rates are the same regardless of which third generation (3G) flavor is adopted--Qualcomm's cdma2000 or the rival W-CDMA.
* Qualcomm is licensing CDMA into many wireless devices, thus mitigating the price erosion occurring in mobile phones. The firm collects a small royalty from each CDMA phone sold.
* Some smaller carriers are switching to CDMA, including U.S. Cellular USM. Nextel NXTL is also likely to conform, now that Qualcomm has agreed to develop a Direct Connect feature that can be used on CDMA networks worldwide.
* The balance sheet is bulletproof, with nearly $2.6 billion in cash and no debt.
Bears Say
Qualcomm's excessive valuation--on a forward basis, 11 times sales and 42 times earnings--is unjustified given that EPS growth will likely be flat in fiscal 2002.
CDMA trails rival standard GSM by a four to one margin. Moreover, 75% of all CDMA subscribers are concentrated in U.S., Korea, and Japan, three very mature cellular markets with low rates of subscriber growth.
Delays in the launch of 3G service pushes Qualcomm's potential stream of royalty payments further into the future.
W-CDMA, the rival to Qualcomm's cdma2000 offering, should become the protocol for 3G. This means competition for chipsets and system software. Moreover, cell-phone king Nokia NOK doesn't use Qualcomm's chips for its CDMA phones.
The quality of earnings is low; Qualcomm repeatedly takes 'special' charges that make pro-forma results look better than actual. <<
- Eric - |
