John:
...Let's see what happens when some employee exercises 1000 shares worth $18 in assets each (post dilution) to some hypothetical shareholder Hudson for $40 each. If you don't like my numbers, feel free to substitute your own ;)
Anyway, using my numbers, Hudson is suddenly holding $22,000 in very real cost that just hasn't yet come home to roost. That is, $40,000 in cost only nets him $18,000 in assets.
Now, in the future, he could hold on until they reach $18 each in present value. Or he might be clever enough to sell these shares to someone much more bullish for $60 each. Who might then moan "blah blah blah, therefore sell QCOM" on a daily basis and still not do so, riding the shares down and up and down and up and down, eventually to settle at $18 or so. This poor soul will eat $42,000 in loss against Hudson's $20,000 gain, but the net effect between them is still a $22,000 loss.
Or instead maybe give up in disgust during a depressing interval of very depressed prices, and deliver them into the patiently waiting hands of Shannon at $15 each, to lose $25,000 to Shannon's $3,000 gain...
Your argument is built on the assumption that the stock price will eventually end up at $18, the "present asset value" you assign (or assume) to be appropriate to the shares.
Let me sketch an alternative and quite possible scenario.
Wireless subscriber growth continues at a 200-250 million/year clip as countries with emerging economies continue to deploy wireless systems as the most cost effective way to bring communications services to the mass population. Total worldwide subscribers pass the 2 billion mark in 2006 when 800 million handsets are sold, equivalent to the roughly 400 million sold to around 1 billion users last year.
Of the 800 million handsets sold in 2006, 300 million are sold to CDMA carriers, and 500 million are sold to GSM/GPRS/WCDMA carriers.
Not that this will matter to Qualcomm, because the full commercialization of the five member family of ZIF MSS6xxx chipsets by the end of 2003/early 2004, plus the sampling and commercialization of the next generation MSM7xxx chipset family in 2004/5 means that every chipset sold by any vendor will have a CDMA component, and most will be multi-mode, multi-band, multi-media, R-UIM, etc. with full worldwide roaming capability. If other chipset vendors don't match Qualcomm's offerings, they'll get shut out of the market. So Qualcomm collects royalties on 800 million handsets sold in 2006. Average handset ASP declines to $150 by 2006 from the present $200+, driven down by lower ASP's in developing countries, offset somewhat by higher ASP's in developed countries where high ASP handsets are sold - that's a decline in the middel of the 5-10% range projected by Qualcomm and many analysts. Scale that 800 million volume through QTL's model at an ASP of $150, a 4.5% average historical royalty rate (which may come down slightly), and the present expense structure which eats up only 8% or so of revenues, and you arrive at revenues of $5.4 billion, EBT of about $5.0 billion.
Qualcomm is at least one generation ahead of the competition in CDMA chipset design and development. There is hardly any 1x competition, and by the time there is, the MSM5xxx family will be standard and the MSM6xxx family will be in production. So Qualcomm gets around 90% of the CDMA chipset market (by all accounts, they have that now, and it's their's to lose), and say around 45% of what is presently the GSM handset chipset market, but which will incorporate a CDMA component, and where Qualcomm should get a commanding market share. So QCT sells about 500 million chipsets in 2006. ASP's for 1x chipsets are presently running $35 (no competition), assume blended ASP's for the entire MSM5xxx/MSM6xxx family run at $30, again with lower priced lower functionality chipsets being balanced by higher priced high end multifunction chipsets. Assume QCT maintains its present GM of 60% on that ASP, R&D increases to $475 million/year to keep up the development pace and keep the competition a generation behind, and SG&A scales with chipset volume. The result is $9.0 billion in revenues and $7.775 billion EBT in 2006.
Net result of QTL+QCT in 2006 is $14.4 billion in revenues, $12.775 billion EBT, and net earnings of about $8.3 billion. Now, crank growth to the 800 million handset level by 2006 through a similar analysis and you wind up with net earnings of $0.75 billion (2002), $1.5 billion (2003), $3.0 billion (2004), $5.5 billion (2005) and $8.3 billion (2006).
Accumulated earnings of about $19 billion, or about $23/share. Can't get to EPS for a moment, couple of minor hair splitting issues to deal with first.
This bottom line does not include any contribution from QWS, and if you consider that half the MSM5xxx and every MSM6xxx chipset is BREW enabled, there could be a decent amount of change there also. By 2006, there will likely be 500 million BREW enabled handsets around (25% of the total), at 1 BREW application download per week per user, $1 per download, and 10% to QWS, that adds up pretty fast - to around $2.6 billion in revenues to QWS at virtually zero cost, because the carriers will be handling the billing and revenue sharing. Some scoff at this idea, but if you were a software developer looking at a 500 million user captive market, at $1/download, even 2.5% market penetration gets you $1 billion revenues/year.
QSI and the bleeding of FCF to cash strapped carriers in emerging markets? Well, we can blow some of the accumulating BREW revenues and cash if you like, but by 2006, QSI will almost certainly have folded its tent, because the market will be at a point where seed capital from Qualcomm will not be needed. More than likely, QCOM will have recouped its investments and returned the $2 billion and change to the corporate coffers. And more recent investments like Reliance may well provide a decent or even impressive return.
Share dilution and the cost to shareholders of employee options, about which you've been preaching from the soapbox for a few months now? Well, mindful of the effective put option selling strategy used by Dell, Microsoft and others as their stock prices appreciated in the late 1990's, Qualcomm has been quietly doing the same through 2006, and has used the put option cash plus the $2 billion recouped from QSI plus maybe a little of the accumulating operating earnings to steadily buy back the 100 million shares of its stock, so the net dilution effect is close to zero, and diluted share count is still around 810 million, despite the exercise of the employee options over the four or so years. Maybe new accounting rules along the way require companies to deduct the estimated cost of employee options at the time of grant from current earnings, but that effect is small on the increasing after tax Qualcomm earnings.
So 2006 EPS comes in at about $10/share, and at a P/E of around 16 (since we assume pessimistically that P/E contraction continues for the next four years as the market re-prices itself), we are at around $160/share. Poor Hudson, who bought at $40/share (or $30 or whatever) in 2002 because he believed in Qualcomm's business strategy and management, and because, well, the price of getting on this train before it left the station just happened to be $40 and he didn't want to be left behind, is sitting on a compound 40% plus annual return on his investment. And Shannon, still standing on his 2002 soapbox worrying about the $22 potential cost to shareholders of employee options, is still patiently waiting for the shares to fall to $15, and is still empty handed.
In 2006, Qualcomm decides it's time to reward its patient shareholders with a one time dividend of $10/share, leaving it with about $11 billion in cash reserves, more than enough to run the business, and presenting Hudson with an additional one time 25% return on his original $40 investment. But wait, there's more - Qualcomm also declares a 2:1 split to get the share price down under $100, and adds that its business has reached a level of maturity such that it intends to pass all future after tax earnings on to shareholders in the form of regular dividends. At the 2006 rate of $8.3 billion that's about $10/share, an additional 25% per annum to Hudson, who paid "only" $40 for his shares, and a not bad 6.25% per annum to anyone buying shares at $160 in 2006.
With wireless growth "slowing" Y/Y to "only" about 200-250 million (in reality a constant growth but not the way financial commentators and analysts view things), even the most boneheaded analyst can figure that 200 million additional users will scale through Qualcomm's business model to an additional $2.2 billion or so of after tax earnings, raising the dividend to about $12.65/share in 2007, or 7.9% at the pre-split $160/share price.
After looking at this from all angles, Warren Buffet declares that he is so impressed with this particular technology company and business model that he buys a 5% stake in the company. Long time skeptic Mucho, long parted from his hedged share position that he bought back in 2002 (by the increasing share price), is so impressed with the stability and growth of Qualcomm's business and earnings that he buys a new stake, just for the steady 7.9% dividend payout. As do countless "value" fund managers, following the sage of Omaha's lead.
And even Shannon, still standing on his soapbox but now without an audience, decides that a 6% to 8% return on his investment isn't bad after all, and buys some of Hudson's shares at the then market price (pre-split) of $160, presenting Hudson with a nice $120 LT capital gain. Hudson doesn't mind parting with some shares, after all, he's held them for 4 years and is overweight in them anyway.
OK, so it's just one potential scenario out of many possible ones, but the overall and CDMA wireless growth numbers are not implausible, the business model scaling is actually realistic, and the bottom line is what it is given the inputs. And presented with some seriousness to show how Qualcomm's business scales with sales volume, despite employee option costs, poor performing past strategic investments, and whatever else you care to throw in.
Now to construct a "dark side" scenario, where all of your's, Mucho's, robv's, Dipy's and others' darkest predictions come true, the ship founders, and we all drown (<g>).
David T.
P.S. As for your offer to take $30 from anyone and receive Qualcomm's current EPS of $0.48/share from you, with guaranteed growth at 15% p/a, for a total of 15 years, no thanks. I will, however, offer to sell you some of my shares for $160 in 2006 for that 6%-8% return, But Hudson is in line before me. |
