QCOM: Waiting for the Invisible Hand
2007-08-17 07:09 (New York)
August 17, 2007
Ittai Kidron George Iwanyc
1 (212) 667-6292 1 (415) 399-5748
Ittai.Kidron@us.cibc.com George.Iwanyc@us.cibc.com
Company Update
Market Weight
Sector Outperformer
Qualcomm
Waiting for the Invisible Hand
Communication Technology
QCOM-OTC (8/16/07) $36.93
Key Indices: S&P 500, NASDAQ
12-18 mo. Price Target $51.00
3-5-Yr. EPS Gr. Rate (E) 20.0%
Shares Outstanding 1,704.0M
52-week Range $47.72 - $34.10
Float 1.6B
Avg. Daily Trading Vol. 1,890,000 Shrs
Dividend $0.56
Div Yield 1.5%
Book Value $9.35 per Shr
Fiscal Year Ends September
LT Debt $0.0M
2007 ROE (E) 18.3%
Preferred Nil
Common Equity $15,932.0M
Market Capitalization $62,928.7M
Convertible Available No
Company Description
Qualcomm is an inventor and a major supplier of digital wireless communications
products, technologies and services based on code division multiple access
(CDMA) technology.
www.qualcomm.com
Earnings per Share P/E
2006 $1.64A 2006 22.5x
2007 $1.97E 2007 18.7x
2008 $2.10E 2008 17.6x
All figures in US dollars, unless otherwise stated.
- We hosted investor meetings with Qualcomm's CEO Paul Jacobs and COO Sanjay
Jha this week. The key takeaway in our opinion is management's recognition that
mistakes were made and that a change in strategy is needed. Management is now
working to fix previous missteps.
- Looking forward, Qualcomm is resetting its legal strategy and reallocating
assets. We look for the company to become more offensive and not as defensive
as it deals with its problems as well as to continue to build a war chest of
critical next gen IP (even outside wireless), to increase leverage.
- The specifics of the conflicts suggest the litigation could linger for a
long time. It seems (and implied by Dr. Jacobs) that only outside pressure (an
"invisible hand" of sorts) will push those involved to resolution. We expect
the legal issues to overshadow the strong 3G fundamental trends.
- For those interested, the underlying business seems to be doing well.
Qualcomm remains focused on growing the CDMA and 3G markets and is working
closely with its customers, although new WCDMA customer Motorola is slow to
develop. 3G continues to see an inflection point.
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required disclosures, including potential conflicts of interest.
See "Price Target Calculation" and "Key Risks to Price Target" sections at the
end of this report, where applicable.
C a n d i d C o m m e n t a r y
We hosted investor meetings with Qualcomm?s CEO Dr. Paul Jacobs and COO Dr.
Sanjay Jha this week at the company?s headquarters in San Diego, CA. They put
in perspective the company?s current legal strategy with candid commentary
about past missteps and the need for change. Although we are positive on
regrouping efforts being implemented, we can?t discount the damage that has
already been done. It will take time and legal maneuvering to change and
reverse some of the negative outcomes. To us, these are first steps in an
uphill battle.
The legal uncertainty not withstanding, the underlying business appears strong
with the company?s product roadmap putting it in a leading position to
capitalize as 3G demand accelerates. It?s disappointing though that the
performance is not receiving any credit from investors, given the legal issues.
We come away comfortable that our thesis on Qualcomm is sound from a
fundamental perspective; we believe the company can continue to deliver strong
quarterly sales and chipset shipments and look for strong execution on the op-
ex front. That said, the legal uncertainty and associated headline risk remain
and we don?t see a near term fix to this issue. A long term approach is needed
for investing in Qualcomm at this point.
T h e E l e p h a n t i n t h e R o o m
The bottom line issue with Broadcom (BRCM-SO) and Nokia (NOK-SP) is that
both companies? objectives would significantly change the terms and financial
model of Qualcomm?s licensing business and open a hornet?s nest of other
licensees looking for the same concessions. Although not dismissive of the
gravity of legal setbacks and uncertainty, Dr. Jacobs indicated he won?t allow
Qualcomm?s licensing model to be jeopardized by a short term fix in either
case.
Dr. Jacobs admitted mistakes were made in handling the Broadcom side of the
legal front. Simply put, he suggested Qualcomm was too focused on Nokia, used
to much of outside counsel versus in-house, and just didn?t have the right
process and controls in place to manage the claims. Although a bit late in the
game, steps are being taken to correct these mistakes.
First, Drs. Jacobs and Jha are both taking a more active role in the legal
actions and making sure that right assets (internal and external) are dedicated
to the Broadcom legal effort. Our interpretation is that with top management?s
focus on Nokia and day to day business execution, those handling the Broadcom
legal load relied too much on Qualcomm?s technical argument (which both
believe is strong, although not proven in the courts) and not enough on legal
procedure (which was lacking).
Second, Qualcomm will properly scale its legal defense and more effectively
allocate its top technical resources (such as Dr. Jha) to make sure both the
legal team and technical team are on the same page. In part this will also
include more offensive legal moves, an area Mr. Jacobs suggested had become
less of a focus as the legal setbacks mounted.
Qualcomm will take legal steps to respond to the ITC injunction, the Santa Ana
case and the San Diego H.264 case. Meanwhile, it is working on technical
workarounds. Dr. Jha expressed comfort that the technical workaround in the
ITC case works and handsets with the new software are already being sold. That
said, both Dr. Jacobs and Dr. Jha emphasized that legal challenges could still
arise and stall adoption and derail this process.
Management also emphasized that the gravity of the Santa Ana case shouldn?t
be overlooked, and Dr. Jha indicated the technical workarounds for the three
patents involved are more complex. A worst case scenario could lead to another
shipment injunction, although the appeals process could delay implementation
(unlike the ITC case where the injunction was immediate).
Negotiations with Broadcom appear to be making no progress. Dr. Jacobs insists
that statements in the press regarding the terms offered by Broadcom shouldn?t
be taken at face value. When asked if Qualcomm could go on the offensive in the
courts, Mr. Jacobs noted that Broadcom?s limited traction in WCDMA is holding
back any immediate action, although we believe that action on this front is
likely. We also note that Qualcomm may seek to expand its intellectual property
outside of its core wireless IP, to add more leverage to its position.
Qualcomm put more of a priority on the Nokia situation from the start, although
based on Dr. Jacobs? comments, progress here, as with Broadcom, is minimal.
There are many facets to the Nokia conflict involving licensing, arbitration,
legal actions (where Qualcomm is on the offensive) and government bodies.
Dr. Jacobs expressed confidence in the arbitration process requested by
Qualcomm, although he also indicated that this could be a slow process (think
one, two or more years out, not months). What is involved in the arbitration
request? Our simple interpretation, by Nokia?s continuing to use Qualcomm?s IP,
Qualcomm believes Nokia has implicitly agreed to renew its license under the
terms of the previous license. No arbitrator has been chosen yet, but this is
likely to happen soon and this effort can move on to the next step.
Dr. Jacobs indicated that face-to-face negotiations haven?t resulted in much
progress. Qualcomm believes that if it is successful in litigating its cases
against Nokia involving GSM/GPRS and EDGE technology, it could gain some
leverage in pushing along negotiations. Cases against Nokia involving GSM
technology are spread throughout the world, but the case filed with the ITC is
more visible and could come to a quicker resolution. The ITC case starts on
9/10/07.
With Broadcom and Nokia, Dr. Jacobs expressed a considerable divide in a
negotiated settlement. We believe the fear is that concessions by Qualcomm,
without offsetting balances from Broadcom and Nokia, will endanger existing
agreements with other licensees. At this point, without external factors
bringing the parties together, the terms Qualcomm is willing to adjust (such as
the length of the contract) are not enough to bring closure.
Depending on the progress with finding an acceptable resolution, Dr. Jacobs and
the board would consider splitting the company to lessen the legal problem if
it was in shareholders best interest. But, Dr. Jacobs also clearly stated that
this is an unappealing option and we would consider it a last-resort option
(and likely would not eliminate all of the legal actions).
O t h e r H i g h l i g h t s
· Core business doing well?Don?t forget that Qualcomm is running a
business and not just a legal operation. The fundamentals of that business
are doing well with 3G traction particularly encouraging. Longer term,
Qualcomm is committed to expanding its IP development and to remaining a
leader in next generation wireless technologies and product integration.
· Samsung and LG?No changes here; both vendors are priorities for
Qualcomm and particularly key to the company?s WCDMA/HSPA chipset
outlook. On this front, Qualcomm indicated that design activity has picked
up and that it will help where it can to push penetration along. That said,
both Samsung and LG are committed to using the best solution they can and
will exert as much pricing pressure as they can.
· Motorola?Progress at Motorola on the WCDMA front appears to be slow.
Qualcomm indicated that a few handset designs are in place, although it
recognizes that there is a lot of internal work at Motorola in its
reorganization that needs to be resolved first.
· Sony Ericsson?Sony Ericsson remains one of the major vendors that
Qualcomm has not been able to penetrate in any meaningful way. Ericsson
(ERIC-SP) and its EMP WCDMA/HSPA platform is well positioned, and there
is nothing to suggest that this will change, in our opinion.
· Splitting unlikely, but an option?Management sees meaningful synergy in
having a combined licensing and chip business, especially as a base for next
generation development. Although there are merits to splitting the business
on the licensing side, management emphasized that such a move doesn?t
necessarily solve all issues. Agreements would still be needed, terms would
still be a sticking point, and litigation around IP would likely still be
involved.
· No new ticking time bombs?Outside of Nokia, there are two other
CDMA/WCDMA contracts that come up for renegotiation in the next ten
years and only one is of significant size. So the royalty outlook (with
Nokia stripped out) is secure, although Qualcomm is careful not to set
precedent with Broadcom and Nokia concessions.
· Buyback unchanged?Qualcomm indicated that a large opportunistic share
buyback is unlikely. The company is committed to the in-place $3B 10b-5
repurchase program, which suggests steady, planned activity, although
there are certain events that can adjust the pace of purchases.
· WCDMA coming along?while WCDMA is seeing strong traction, Qualcomm
is still focused on pushing along the migration from GSM/EDGE to
WCDMA/HSPA. Through a combination of price point and compelling features
Qualcomm is working to accelerate the pace of adoption. Key to low end
traction is integration, and Qualcomm sees this as a HEDGE (HSPA and
EDGE) solution, but probably not a 2008 volume event.
· It?s not just 3G?To be sure, Qualcomm is bullish on the outlook for its 3G
roadmap. However, it is not overlooking other technologies in its
portfolio. The company appears to be more committed to monetizing other
wireless technologies including GPS, Bluetooth, WiFi, and its integrated
Snapdragon platform. All areas have seen positive developments in recent
months.
P r i c e T a r g e t C a l c u l a t i o n
We have a $51 price target on the shares of Qualcomm, which is based on a 24x
multiple of our FY08 earnings estimate of $2.10 per share. We note that this
excludes a royalty contribution from Nokia and that any change in the legal
proceedings with Nokia would suggest possible upside. Thus our price target
assumes a worse case scenario regarding Nokia.
We believe a premium to the group average multiple of roughly 15x is
warranted, given the company?s industry-leading margins, leveraged business
model (fabless and licensing), and the growth prospects of CDMA based
technologies.
K e y R i s k s t o P r i c e T a r g e t
Qualcomm is the primary supplier of CDMA base band chip sets to the mobile
handset industry and receives royalty payments from the shipment of any CDMA
handset. The company is subject to risk due to the overall outlook for CDMA
growth and pricing pressures that may develop. Furthermore, its shares are
subject to the perception of the health of the overall wireless industry and
the expectations for the ramp of 3G WCDMA and EV-DO. If 3G take up is slower
than anticipated, investor perception could suffer.
The company?s inability to gain market share in WCDMA chip sets may also
affect the stock price. In addition, the company?s efforts to drive additional
CDMA acceptance, such as BREW and mediaFLO, could fail while costing it
considerable R&D effort. Recently, a suit was filed against the company
claiming unfair competition relating to the royalty rates it charges from its
customers. If resolved unfavorably, the results of this suit could negatively
impact the company?s earnings.
The recent decision by the ITC (discussed in this note) imposing a ban on new
shipments could also negatively impact earnings depending on Qualcomm?s
success in dealing with this issue.
Exhibit 1.
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Exhibit 8.
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document.)
Our EPS estimates are shown below:
1 Qtr. 2 Qtr. 3 Qtr. 4 Qtr. Yearly
2006 Current $0.39A $0.41A $0.42A $0.42A $1.64A
2007 Current $0.43A $0.50A $0.55A $0.49E $1.97E
2008 Current $0.50E $0.52E $0.53E $0.55E $2.10E
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1 CIBC World Markets Corp. makes a market in the securities of Qualcomm.
Important Disclosure Footnotes for Companies Mentioned in this Report that Are
Covered by CIBC World Markets:
Stock Prices as of 08/17/2007:
Broadcom Corp. (1) (BRCM-NASDAQ, $33.39, Sector Outperformer)
LM Ericsson AB (1) (ERIC-OTC, $34.85, Sector Performer)
Motorola, Inc. (2f) (MOT-NYSE, $16.06, Sector Outperformer)
Nokia Corporation (NOK-NYSE, $28.40, Sector Performer)
Companies Mentioned in this Report that Are Not Covered by CIBC World Markets:
Stock Prices as of 08/17/2007:
LG Corp. (003550-KS, (KRW)49800.00, Not Rated)
Samsung Electronics Co. Ltd. (005930-KS, (KRW)687000.00, Not Rated)
Sony (SNE-NYSE, $46.74, Not Rated)
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CIBC World Markets Price Chart
Ticker Date Closing Price Rating Price Target Coverage
HISTORICAL PERFORMANCE OF CIBC WORLD MARKETS' RECOMMENDATIONS FOR
QUALCOMM (QCOM)
QCOM 10 Jan 05 43.15 SP None Ittai Kidron
QCOM 16 May 05 35.34 SO 45 Ittai Kidron
QCOM 20 Jul 05 36.09 SO 47 Ittai Kidron
QCOM 21 Sep 05 43.73 SO 50 Ittai Kidron
QCOM 04 Dec 05 45.2 SO 53 Ittai Kidron
QCOM 07 Mar 06 47.86 SO 56 Ittai Kidron
QCOM 03 May 06 51.75 SO 60 Ittai Kidron
QCOM 20 Jul 06 35.85 SO 45 Ittai Kidron
QCOM 13 Mar 07 41.83 SO 47 Ittai Kidron
QCOM 26 Apr 07 45.3 SO 51 Ittai Kidron
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