QCOM: OUTPERFORMS THE BOTTOM LINE ESTIMATE--UPGRADING TO "STRONG BUY"...
Bankers Trust Research/BT Alex. Brown Research
Brian Modoff,Ian Toll
April 21, 1999
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QUALCOMM INCORPORATED [QCOM] "STRONG BUY"
Outperforms The Bottom Line Estimate--Powerful Earnings Leverage Derived
From
Infrastructure Divestiture--Strong Handset, ASIC, Royalty Revenues--
Raising
Estimates--Upgrading To "Strong Buy"
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Date: 04/20/1999 EPS 1998A 1999E 2000E
Price: 140.63 1Q 0.58 0.65 1.32
52-Wk Range: 177 - 38 2Q 0.25 0.82A 1.19
Ann Dividend: 0.0 3Q 0.33 1.19 1.50
Ann Div Yld: 0.00% 4Q 0.66 1.25 1.38
Mkt Cap (mm): 10,491 FY(Sep.) 1.82 3.92 5.40
3-Yr Growth: 20% FY P/EPS 77.3X 35.9X 26.X
CY EPS 1.89 4.58 5.67
Est. Changed Yes CY P/EPS 74.4X 30.7X 24.8X
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HIGHLIGHTS:
--2Q 1999 sales and EPS (excluding charges) of $932.0 million and $0.82
versus our expectations of $927.2 million and $0.60 (consensus: $0.59).
--As expected, the Company is benefiting from strong CDMA subscriber
growth in the U.S., Korea, Japan, and Brazil.
--Key growth drivers in the quarter were CDMA handsets, ASICS, and
royalties.
--Pro forma presentation indicates the powerful earnings leverage afforded
by the unprofitable infrastructure segment divestiture (to Ericsson).
--Increasing forward earnings estimates meaningfully, raising 12-month
price target to $200 (>35x our CY2000 EPS estimate of $5.67).
--Upgrading rating to "strong buy."
DETAILS:
Qualcomm reports 2Q 1999 revenue and EPS (excluding charges) of $932.0
million and $0.82 versus our expectations of $927.2 million and $0.60. The
consensus EPS estimate was $0.59. Results included one-time charges of
$166 million, mainly related to the sale to Ericsson of the Company's
terrestrial wireless infrastructure division. With the effect of these
charges included, the company recorded a net loss of $43 million or $0.59
per share.
Strong results are consistent with our expectations that Qualcomm would be
the beneficiary of strong CDMA subscriber growth in the U.S., Korea, Japan,
and Brazil. The company is benefiting from (1) significant increases in
royalties due to subscriber growth, (2) its dominant position in the CDMA
chipset market, (3) strong handset sales, assisted by the fact that
formidable new CDMA handset vendors such as Motorola and Nokia are still
ramping volumes and have not yet fully entered the market. Importantly,
the sale of the company's infrastructure division to Ericsson has added
significant earnings leverage, as illustrated below.
With the albatross sold to Ericsson, assured growth in pure-margin
royalties, and with the continued strong performance of the company's
Communications Division product lines, we have raised our forward estimates
significantly and are advancing our rating to "strong buy" with a 12-month
price target of $200 (based on >35x our CY00 EPS estimate of $5.67).
PRO FORMA NET INCOME DEMONSTRATES POSITIVE EFFECT OF INFRASTRUCTURE
DIVISION SALE
These impressive results significantly exceeded Street expectations. Even
more surprising, however, were the pro forma financial results provided by
the Company that showed the effect of removing costs associated with the
infrastructure division, which had been losing money and had exerted a drag
on the company's profitability. The division has been sold to Ericsson as
part of the two companies' broad cross-licensing agreement for CDMA. With
the infrastructure division excluded, the company's pro forma sales for the
quarter would have been $908 million or 2.6% lower than reported sales,
while pro forma EPS would have been $1.20, nearly 50% higher than reported
operating EPS. The disparity between reported and pro forma earnings is a
significant demonstration of the earnings leverage afforded by the
unprofitable infrastructure segment divestiture.
The transaction is expected to close in late May. Therefore, about 2/3 of
the F3Q99 will include the negative effect of the infrastructure business.
The company will also provide pro forma results for the F3Q99.
COMMENTS BY PRODUCT AREA
Key growth drivers in the quarter were CDMA handsets, ASICS, and royalties.
Further comments on each of these product/revenue categories follows:
ASICS
The ASIC division had an extremely strong quarter, shipping nine million
MSM phone chips, up sequentially from 5 million last quarter. The
quarterly book-to-bill ratio for the ASICs business was 1.7x, indicating
that next quarter sales will continue to ramp strongly.
Qualcomm has a very strong presence in the CDMA chipset market. The
company has shipped over 40 million chipsets cumulatively, and today has
approximately 90% market share in the CDMA phone chipset segment and 70%
market share of the market for infrastructure chipsets (the handset segment
is the larger and more important market, accounting for about 90% of
division sales). Please see our 3/31/99 research note for an extensive
discussion of Qualcomm's competitive advantages in the CDMA ASIC market.
However, Qualcomm is not likely to maintain its current commanding market
share. Two leading handset vendors, Nokia and Motorola, primarily use
their own chipsets (a portion of Motorola's CDMA products are OEM'd from a
Korean manufacturer that does use the Qualcomm chipset). As these
companies' CDMA handsets gain market share, Qualcomm's ASIC market share
should decline from its current unsustainably high level. Our current
numbers assume that Qualcomm's handset ASIC market share will decline from
83% for the full-year FY99 to 59% in FY00.
Although Samsung recently announced it would develop an internal CDMA
chipset, management stressed that they expected zero impact on sales this
FY, and a minimal impact in future years. They suggested that Samsung was
developing an internal second source but should continue to use Qualcomm as
primary vendor. Our checks into Korea indicate that Samsung will use its
own chipset late this year in a low-end handset targeted at the domestic
Korean market. As long as Qualcomm continues to produce leading edge CDMA
ASICs, we believe that major handset vendors such as Samsung will be
compelled to use Qualcomm as a key supplier.
Bottom line, Qualcomm can still generate strong chipset sales growth with
some market share loss due to handset ASIC unit growth of approximately 49%
annually over the next five years. Further, higher unit volumes and cost-
advantaged redesigns should allow Qualcomm to stay ahead of the declining
price curve. We are forecasting that the ASICs gross margin will increase
from 43.5% this year to 45.0% in FY00.
HANDSETS
Qualcomm shipped 1.7 million CDMA phones in the quarter, up sequentially
from the seasonally strong December quarter. Yields were strong. Qualcomm
has a strong presence in CDMA handsets, having shipped over 10 million
units cumulatively. We estimate the company's 1998 CDMA handset market
share was 26%.
Last month, during a visit to the QPE manufacturing facility, we noted nine
handset production lines and 10 final assembly and test lines. The
facility is running 24/7 and current capacity is 650,000 phones per month
(this volume was achieved in February). The company is currently in
preproduction on the "Thin Phone" and will begin producing in commercial
volumes next month. The "pdQ Smart Phone" is also in preproduction and
will enter commercial production next month, although volumes will be
significantly lower. The "Q" phone production was clearly at low levels.
Qualcomm continues to ramp the production of IS-95 CDMA handsets and
anticipates reaching 1 million in monthly capacity by year-end.
The company also mentioned some components shortages. The company would
not identify exactly which components are in short supply, but
characterized it as a general industry issue that may be impacting other
handset vendors, including other digital air interfaces. We note that this
problem occurred in 2Q, but did not impact the company's ability to meet
our expectations.
In the future, the challenge for the company, in our view, will be to prove
they can compete with the top three handset vendors (Nokia, Motorola and,
eventually, Ericsson) for market share in an increasingly competitive CDMA
handset market. All of these companies have significant brand name
recognition, economies of scale, and distribution versus Qualcomm. We are
assuming that Qualcomm's CDMA handset market share falls to 21.4% for FY99
and 16.2% in FY00. We are assuming that Qualcomm's gross margin on phones
improves to 22% for full-year FY99 and 25% in FY00.
LICENSE/ROYALTIES
License and royalty fees increased significantly, to $77 million for the
quarter. This is an impressive number in that it is nearly all royalties
and not one-time licensing fees. The year-ago L&R fees of $70 million
included a significant amount of one-time license fees, and an upward
adjustment of $18 million due to a change in accrual policies. The higher
percentage of royalties is significant because they are a recurring revenue
stream. Higher royalty payments are contributing to significantly higher
blended margins. We are forecasting $281 million in L&R for full-year FY99
and $375 for full-year FY00.
OMNITRACS
OmniTRACS continued to be a good business. 11,000 OmniTRACS units were
sold in the quarter, bringing the cumulative total to 280,000.
GLOBALSTAR
The Globalstar LEO satellite communications network has launched over 20
satellites. Qualcomm has shipped 38 gateways, and will not ship any
additional gateways unit commercial launch. Total contract services
revenues were $81 million in the quarter.
BALANCE SHEET AND CASH FLOWS
Balance sheet metrics were generally strong. Cash decreased to $204.6
million. 2Q99 from $237 million in 1Q. Cash from operations was strongly
positive. The company paid the balance of its bank facility down to zero.
Accounts receivable increased at a rate slightly below revenue growth, DSOs
were down sequentially from 82 days to 79 days and inventory turns improved
from 7x to 8.9x. The positive cash flow this quarter may obviate the need
for additional financing this year.
RAISING ESTIMATES AND RATING
The savings obtained through the sale of the infrastructure division are
more significant than previously assumed, and that adjustment adds
substantially to our earnings forecasts. In addition, stronger royalty
revenues (which essentially drop to the bottom line) are driving an
improved margin outlook. As a result, we are increasing our forward
earnings estimates meaningfully:
PREVIOUS REVISED
BTAB EST. BTAB EST.
3Q 1999 Sales $927.2 mil $812.7 mil
3Q 1999 EPS $0.60 $1.19*
1999 Sales $3,787.1 mil $3,805.3 mil
1999 EPS $2.77 $3.92
2000 Sales $4,002.5 mil $3,642.0
2000 EPS $4.35 $5.40
*The company will take an additional charge of about $100 million related
to the infrastructure division sale in the F3Q99. With this charge
included, we are forecasting EPS of $0.42.
We are increasing our rating from "buy" to "strong buy" and raising our 12-
month price target to $200 (>35x our CY2000 EPS estimate of $5.67). |
