QUALCOMM, Inc. (QCOM)
WCDMA and wireless internet should eventually make
QUALCOMM forget current problems in China and Korea.
By Marc H. Gerstein
June 12, 2000
QUALCOMM, Inc. is a provider of digital wireless communications products, technologies and
services based on its Code Division Multiple Access (CDMA) technology. The Company designs,
develops, manufactures and markets CDMA subscriber products and designs, develops and markets
CDMA chipsets and system software. The Company also licenses and receives royalty payments on its
CDMA technology from major domestic and international telecommunications equipment suppliers.
In addition, QUALCOMM designs, manufactures and distributes products and provides services for its
OmniTRACS system. The Company also has contracts with Globalstar L.P., a low-Earth-orbit satellite
system utilizing CDMA technology, to design, develop and manufacture subscriber products and
ground communications systems and to provide contract development services. In December 1999,
the Company announced plans to sell its phone business to Japan's Kyocera Corporation.
Industry: Communications Equipment
Sector: Technology
Recent Price $
72.69
52 Week High $
200.00
52 Week Low $
25.30
Avg Daily Vol (Mil)$
20.31
Mkt. Cap. (Mil)
53,864.43
Price/Earnings (TTM)
97.96
Price/Sales (TTM)
14.35
Price/Book (MRQ)
9.87
Price/Cash Flow (TTM)
77.41
Can You Guess?
Can you guess which Market Guide screen QCOM, one of the more prominent
new economy celebrity stocks, appears on? You might start by wondering about
our momentum-oriented screens, but lately, much of QCOM's momentum (relating
to the stock price) has been in the wrong direction. We have several
growth-oriented screens that might seem natural for a company like QCOM. We
also have one that searches for companies whose shares have, and deserve, high
P/E multiples.
In fact, QCOM is presently in the Strong Operating Margins screen, one of those I
use to find solid companies that perform well in the basic day-to-day business
fundamentals, the sort of "good companies" I'd be willing to hold even if through
periods of adverse market conditions. That screen certainly is not designed to
weed popular new economy names. But in all the conversation there is about
companies like QCOM, talk usually isn't focused on mundane fundamentals.
Maybe It's Time
QCOM shares have definitely not fared well in 2000. Obviously, one factor is the
severe downturn that has afflicted the one-hot new economy stocks. Even before
we start look at fundamentals, valuation (the relationship between stock prices
and current or future EPS) alone justified some sort of slide. And as to
fundamentals, many investors started to look closely and ask hard questions
about companies they once loved unconditionally.
Worries about valuation were, and still are, quite proper for QCOM shares. Also,
some other questions surfaced. But before addressing these, let's take a look at
QCOM's basic fundamentals.
Unlike many firms in the new economy, QCOM is in the black. And as might be
expected of any company on the Operating Margin screen, QCOM runs its
business very efficiently.
Profitability Ratios (%)
Company
Industry
Sector
S&P 500
Gross Margin (TTM)
43.29
45.61
53.99
49.80
Gross Margin - 5 Yr. Avg.
34.76
41.28
51.47
48.61
EBITD Margin (TTM)
17.24
10.12
19.72
23.34
EBITD - 5 Yr. Avg.
10.86
6.99
18.36
21.45
Operating Margin (TTM)
16.71
-2.40
14.06
18.25
Operating Margin - 5 Yr. Avg.
5.32
1.63
11.68
17.22
Pre-Tax Margin (TTM)
25.11
11.34
18.31
17.90
Pre-Tax Margin - 5 Yr. Avg.
6.20
2.90
13.38
16.66
Net Profit Margin (TTM)
14.62
-2.56
10.99
12.27
Net Profit Margin - 5 Yr. Avg.
4.62
0.55
8.24
10.26
Effective Tax Rate (TTM)
41.78
34.67
33.10
34.68
Effective Tax Rate - 5 Yr. Avg.
24.41
39.87
34.71
35.46
Efficiency
Company
Industry
Sector
S&P 500
Revenue/Employee (TTM)
403,247
298,831
411,019
533,686
Net Income/Employee (TTM)
58,949
37,139
82,580
69,968
Receivable Turnover (TTM)
4.57
5.55
7.41
9.08
Inventory Turnover (TTM)
10.43
5.28
9.41
9.65
Asset Turnover (TTM)
0.92
0.84
0.98
1.04
These tables, taken from the current Market Guide Comparison Report on QCOM,
show the company tops the industry in most categories. And I regard gross
margin, one where QCOPM still trails its peers, as less important. Different
methods of labeling various costs as direct or overhead can affect gross margin
comparisons even among companies in the same industry. But operating margin,
which factors in both direct and overhead costs, is more likely to be comparable
from one firm to the next. (Click here for more discussion of this topic.)
Notice, in the Profitability table, the various Trailing Twelve Month (TTM) figures are
way above related 5-year averages. We see a similar pattern of improvement for
the Communications Equipment industry as a whole. But the up-tick is more
substantial for QCOM. This is more pronounced in the following table.
Management Effectiveness (%)
Company
Industry
Sector
S&P 500
Return On Assets (TTM)
13.45
3.01
10.41
9.58
Return On Assets - 5 Yr. Avg.
4.42
2.80
10.41
8.98
Return On Investment (TTM)
16.48
5.65
14.91
14.81
Return On Investment - 5 Yr. Avg.
5.79
5.02
15.26
14.01
Return On Equity (TTM)
19.71
10.79
19.17
23.64
Return On Equity - 5 Yr. Avg.
7.91
6.73
19.50
22.00
QCOM rushes beyond its Communication Equipment industry comparison. When
we compare the company to the Technology sector and the S&P 500, our first
reaction may be that we're getting mixed signals. But let's think a bit more about
the patterns we see.
In every instance, QCOM is markedly superior when we look at extent to which
the TTM number is an improvement over the 5-year average. With Return on
Assets and Return on Investment, QCOM's TTM figures surpassed all
benchmarks. The TTM Return on Equity number is heading in that direction (once
again, compare the TTM and 5-year average) but isn't there yet. But Return on
Equity is a number that can be easily inflated if a company chooses to take on
more financial risk (i.e. debt). (Click here for an explanation of why this is so.) In
light of that, look at this:
Financial Strength
Company
Industry
Sector
S&P 500
Quick Ratio (MRQ)
4.06
3.96
2.76
1.21
Current Ratio (MRQ)
4.75
4.80
3.26
1.71
LT Debt to Equity (MRQ)
0.00
0.23
0.18
0.60
Total Debt to Equity (MRQ)
0.00
0.28
0.24
0.90
Interest Coverage (TTM)
66.64
11.00
14.38
10.08
QCOM's balance sheet is stronger than those of the other benchmarks. So when
it comes to Return on Equity, the very least we can say of QCOM is that it offers
modestly below-average returns coupled with substantially below-average financial
risk. But again, note the directional trend of Return on Equity. If the company
stays the course, we could soon be looking at above-average (returns even
compared with the S&P 500) coupled with below-average financial risk.
Ultimately, what we have here in QCOM is a company with new economy stature
and growth prospects (which will be discussed below) and a record of performance
that ought to prove interesting even to old economy textbook diehards. Note, of
course, that I'm still talking about the company. The stock is a separate issue that
will also be addressed below.
QCOM's Grail: CDMA
QCOM's primary business opportunity can summed up in four letters: CDMA,
which stands for Code Division Multiple Access. This is a method of transmitting
information, thus far, voice, over airwaves. CDMA does this by attaching a unique
code to packets of voice data. Only one receiver in the world can recognize that
code. It gathers all appropriately coded packets together, and reassembles them
into recognizable conversation.
The competing standard, TDMA (Time Division Multiple Access) doesn't use
codes to distinguish one voice packet from another. Instead, it assigns a unique
time slot to each voice packet and sends them over the airwaves (this strikes me
as being similar to assigned takeoff and landing slots at airports). Those who are
in the know technically seem, as far as I (and just about everyone else in the
investment community) can gather, to agree that CDMA allows more
conversations to flow more rapidly within a given spectrum.
When you think of wireless, you also have to think in terms of generations. The
first was analog. The second generation was digital (wherein signals are converted
to numbers, rather than waves). Most cell phone users today are in the second
generation, which is often referred to as 2G. But we're hearing all sorts of talk
about wireless internet. Pushing data over the airwaves is the prime feature of the
emerging 3G (third generation) wireless.
In the 2G world, CDMA and TDMA (as well as GSM, a TDMA-like standard that's
popular in Europe) are both widely used. Actually, TDMA has been described as a
digital version of the old analog transmission standard. As to 3G, it's too early to
know for sure, but the weight of expert opinion seems to be saying that CDMA,
more particularly, WCDMA (a wireless version of CDMA) will dominate. Nokia
(NOK), whose claim to fame so far is its leading share in the market for 2G
handsets, is working hard to beef up its presence in CDMA in anticipation of that
scenario.
Don't assume TDMA and GSM plan passively sit out 3G. There is another 3G
standard, EDGE, that facilitates transmission of data using TDMA and GSM. But
on a cost-benefit comparison, EDGE doesn't measure up to CDMA.
QCOM, as the proprietor of the CDMA and the WCDMA standards, makes money
not just by manufacturing and selling equipment, but also through fees it earns
licensing CDMA and WCDMA to other manufacturers. The transition from 2G to
3G can therefore have a powerful financial impact on QCOM. The TTM numbers
we saw above reflect an environment in which QCOM shared the pie with GSM
and TDMA. In the future, QCOM will probably have a much bigger chunk of the
pie, and as far as royalties go, some suggest QCOM will have the entire pie. If
that happens, the improvements we saw from 5-year averages to TTM represent
just a modest preview of what's coming down the road.
An Imperfect World
Nowadays, as we see analysts and investors get frantic when companies miss
estimated EPS by even pennies, it's obvious Wall Street seeks nothing less than
perfect predictability, execution and environmental factors. In such a perfect world,
QCOM would march straight ahead and CDMA would see its market share chart a
smooth course up to 100%. Unfortunately, the world we live in is not perfect and
neither is QCOM's march to WCDMA. We now see instances in which some
segments of the world aren't following the exact script envisioned by those who
were bullish on QCOM when its stock was priced at 200.
First, subsidies for handset purchases ended in Korea. Hence consumers there
no longer benefit from extreme bargains on new phones, as so many do in the
U.S. This may not impact subscriber growth much, since that market is fairly
mature. But it may slow the pace of upgrades.
Second, there's disappointment over the failure of China Unicom to immediately
jump on the CDMA bandwagon, as many expected it to do. There are reports that
Unicom will wait three years and go directly to WCDMA. Other reports indicate
stories about such delays are exaggerated.
Analysts contend that their estimates now reflect these disappointments. But
realistically, situations such as these defy precise forecasting. So if you chose to
own the stock at present, be prepared with the prospect of some unfavorable
earnings surprise in the near future.
The Main Event
In assessing an appropriate course of action for QCOM stock, we should start by
comparing the P/E to the projected growth rate.
Earnings Per Share Estimates
Diluted EPS
# of
Ests.
Mean
Est.
High
Est.
Low
Est.
Std.
Dev.
Proj-
P/E
Quarter Ending 06/00
19
0.27
0.29
0.26
0.01
--
Quarter Ending 09/00
17
0.30
0.33
0.28
0.01
--
Year Ending 09/00
21
1.08
1.11
1.05
0.02
71.51
Year Ending 09/01
21
1.42
1.63
1.27
0.08
54.37
LT Growth Rate
14
36.21
61.00
0.00
8.58
--
The PEG (P/E-to-Growth) ratio is 1.97 if we use the EPS estimate for fiscal 9/00
to compute the P/E and 1.50 if we use the 9/01 estimate. Both are higher than
what many investors like to see. But how often do investors in new economy
stocks get to see PEG ratios that low for such high quality companies? Here's
how QCOM stacks up now compared with some other modern market superstars.
PEG Ratio with P/E based on ...
Ticker
Company
Current Yr. EPS
Next Yr. EPS
CSCO
Cisco Systems, Inc.
3.78
2.89
JDSU
JDS Uniphase Corporation
5.85
3.77
NOK
Nokia Corporation
2.43
1.85
ORCL
Oracle Corporation
5.00
3.95
QCOM
QUALCOMM, Inc.
1.97
1.50
Q
Qwest Communications Int.
7.06
3.76
QCOM is the least expensive stock in the group. Obviously, all these stocks are
high-fliers and they still contain much valuation risk. They definitely aren't for
everyone. But if you are a new economy investor willing to take the risks that go
with it, you can't help but raise an eyebrow at QCOM's relative valuation.
Obviously, this isn't a random occurrence. The Korea and China situations, and
the accompanying prospect of negative earnings surprises, are precisely the kind
of corporate baggage that can cut into a stock's relative valuation. The task, for an
investor faced with such a situation, is to look at the baggage and decide whether
or not it should be accepted in light of the stocks' valuation.
Doing that, I focus on the big picture for CDMA/WCDMA. Are the events in Korea
and China fatal? I don't see it that way. We know wireless is going 3G, with its
data transmission needs. We know WCDMA |
