I believe that Marc Cabi, for a reason known only to him, is deliberately mischaracterizing Qualcomm's gross margins and handset profitability. To begin with, QC reports consolidated communications systems (comm sys) gross margins which incorporate multiple business units including: ASICs (application specific integrated circuits), cellular handsets, infrastructure and Omnitracs. This reporting framework makes it difficult to readily analyze segment margin performance because some units within this amalgam, such as ASICs and Omnitracs, have relatively high gross margins, while others, such as cellular infrastructure, are in start-up mode and currently have comparatively low margins.
Analysis of the handset operation (Qualcomm Personal Electronics--QPE) is further complicated since the business unit is structured as a joint venture agreement between Qualcomm and Sony. To understand the arrangement, you must divide the QPE business into two functions: manufacturing and sales. Conceptually, QPE is a captive factory that produces handsets for both Sony and Qualcomm and transfers this output to the respective sales and marketing arms of these two companies at relatively low margin. Sales from QPE to Sony, although consolidated in Qualcomm financials, therefore afford QC a relatively low gross profit margin since Sony Corporation enjoys the marketing and distribution profit. Conversely, sales of the QCP and 'Q' products provide QC with much higher margins (with the 'Q' being still more profitable than the 'QCP' family), since Qualcomm captures the marketing profit. To understand this, consider that if Sony sales accounted for 50% of QPE output, and had (for example) 10% gross profit margins while Qualcomm products (QCP and "Q") represented the balance, then the Qualcomm products would need to produce 30% gross profit margins in order for consolidated gross margin to be 20%. As I noted before, this structure makes is possible to mischaracterize QC's actual handset profitability.
QC's comm system revenues are therefore "grossed up" by the low margin, pass through, sales to Sony. This creates an illusion that QC's margins are materially substandard, and allows critics, such as Marc Cabi, to distort the company's actual performance. Understand that the Sony relationship brought QC (a) access to suppliers and distribution channels that otherwise may have taken years to develop, (b) a powerful brand name ("Sony") to offer service providers and (c) VOLUME. QPE is the largest customer for QC's ASIC operation, and QPE's volume has helped the company drive down ASIC costs (and achieve other manufacturing economies of scale). It may be difficult to analyze, but the structure does make good business sense.
Let's flip the argument around for a second. Qualcomm is the highest volume producer of CDMA phones and the highest volume producer of CDMA ASICs. Moreover, it supplies ASICs to most other CDMA handset vendors (with the exception of Motorola and Nokia) and ALL CDMA handset vendors must pay QC royalties. Structurally, QC therefore has a significant cost advantage because (a) it does not have to "pay" royalties to itself and (b) its ASIC costs, on a fully allocated basis, are far lower then its competitors (who either buy ASICs from QC or are manufacturing their own chips in much lower volume). QC is therefore in a structurally superior position with the handset marketplace.
Finally, it is important to note that until recently, Qualcomm had a virtual monopoly on CDMA handsets and was in a position to possibly "extort" excessive prices from its customers (due to their lack of alternatives). Instead, QC's strategy has been to push down its handset prices as rapidly as possible to achieve pricing parity with GSM handsets. This strategic decision penalized near-term results, but was the correct decision to accelerate CDMA's worldwide deployment, to build a consumer electronics franchise and to foster loyalty from network operators. Wall Street operates with very short time lines, and with many analytical agendas, but QC has been managed to build a very large and very successful enterprise with a long-duration opportunity. It takes some effort to understand all the moving pieces, but that (ostensibly) is what analysts are paid to do.
Best Regards,
Gregg |
