from BTAB analysts Brian Modoff and Ian Toll QCOM: Company
Visit--Current Business Strong--Reiterate "Buy" Rating
HIGHLIGHTS:
Yesterday, we visited Qualcomm and met with certain members of management
including Don Schrock the President of the ASIC division, and toured the
QPE handset facility.
Driven by the strong growth in CDMA networks and subscribers, ASIC sales
continue to be robust and are likely to be up sequentially in 2Q from 1Q.
ASIC order rates are very strong with visibility two quarters out.
Qualcomm has a very solid CDMA ASIC roadmap that should allow the company
to retain significant market share.
Qualcomm's CDMA handsets are also being positively impacted by this strong
demand. Handset unit volumes are likely to be up sequentially in 2Q.
However, due to price cuts implemented in January, handset revenues should
be down sequentially.
Due to the combination of continued strong ASIC and handset demand, plus
the cost savings due to the sale of the infrastructure division, we are
increasing our 2Q, FY99 and FY00 earnings estimates.
Qualcomm's challenges, in our view, are maintaining a strong market share
in the ASIC business and proving that they can compete in the increasingly
competitive CDMA handset market.
We are reiterating our "Buy" investment rating on the shares and increasing
our price target to $130 (about 30x our FY00 EPS estimate of $4.35).
DETAILS:
Yesterday, we visited Qualcomm and met with certain members of management
including Don Schrock the President of the ASIC division, and toured the
QPE handset facility. The following is a overview of our visit.
CDMA Chipsets
Qualcomm has a very strong presence in the CDMA chipset market with
approximately 90% market share of the MSM (Mobile station modem) market for
CDMA handsets and 70% market share of the market for infrastructure
chipsets.
Management identified the following as reasons for their competitive
advantage:
1) Complete solution: The company provides a complete CDMA solutions in
both hardware and software. Further, supplying chipsets for both handsets
and base stations allows Qualcomm to incorporate applications such as high
speed data at the system level. By maintaining system level expertise, the
company is able to keep an infrastructure perspective to its ASIC
development effort. This is a key differentiating factor when comparing
the company's products to competitors that are strictly handset ASIC
focused. This combination has helped Qualcomm to regain certain customers
back from competitors.
2) Volume: Qualcomm has shipped 35 million MSMs to date. The company's
foundry capacity is being supplied by IBM and Intel for current generation
designs. Taiwan Semiconductors has been selected as second source for the
new MSM 3000 to IBM. Qualcomm has no capacity constraint issues.
3) Price: Qualcomm's ASIC price cuts are averaging 30-35% annually. These
price cuts are being more than matched by part count reductions. For
example, in 1997, Qualcomm's handset designs using the MSM 23XX required 13
ICs. By Q3/98 the number was reduced to 11 ICs using the MSM 3000 (3.0
volt chipset). The MSM 3100 (1.8 volt chipset) reduces this number to 8
ICs. The MSM 3500, scheduled for release in Q3/00, reduces the number of
ICs down to 4. Qualcomm's ASIC gross margins are continuing to improve due
to part count reductions and volume efficiencies through their foundry
manufacturers. Going forward, ASPs should move from declining to flat as
more parts are incorporated onto the chipset.
4) Excellent quality and reliability - The company meets its scheduled
delivery dates. Further, Qualcomm has experienced no significant recall
issues.
5) Resources: Qualcomm has the largest dedicated CDMA ASIC team in the
industry with 125 software engineers and 400+ chip hardware engineers.
6) Vision: The company has a strong road map for future products. The MSM
3100 is due to start sample deliveries in September and production in
Q1/00. The MSM 3100 incorporates silicon germanium technology through IBM
and will offer 300+ hours of standby time. The MSM 3500 will incorporate
additional silicon germanium technology and offer talk times twice that of
the MSM3000. The MSM4100 supports IS95 HDR (high data rates of up to 1.8
Mbps) and should start shipping in Q1/00. The MSM4000 series will support
both voice and high-speed data for handsets and should start delivery some
time around 2001. Finally, the MSM5000 series for CDMA2000 third
generation applications should be available for field trials around mid-
year 2000.
Qualcomm currently dominates the CDMA chipset market. However, two of the
top three handset vendors, Nokia and Motorola, primarily use their own
chipsets (handsets represent 90% of CDMA ASIC revenues). As these
companies' CDMA handsets gain market share, it will likely to cut into
Qualcomm's market share. Somewhat offsetting this market share loss is
handset ASIC unit growth of approximately 49% annually over the next five
years.
Qualcomm will need to increase its presence with the major handset vendors.
Qualcomm is targeting Ericsson as a new customer for their CDMA handset
ASICs (Ericsson will be using the Qualcomm infrastructure ASICs in their
base station offerings). In addition, Qualcomm is starting to supply
Motorola with handset ASICs through a low-end CDMA handset that is
manufactured in Korea for Motorola.
Current Quarter Update
Driven by the strong growth in CDMA networks and subscribers, ASIC sales
continue to be robust and are likely to be up sequentially in 2Q from 1Q.
We are forecasting $191 million in ASIC revenues for 2Q, up from $138
million in 1Q. ASIC order rates are very strong with visibility two
quarters out. Specifically, Korea is strong due to domestic demand and
increasing handset exports into the US and Latin America. Japan was off to
a slow start, but is starting to pick up. In April, the country should
have nationwide CDMA coverage with three key markets coming on-line
(including Tokyo). Handset vendors Toshiba, Hitachi and Sanyo all should
have 80 gram CDMA phones available for the April launch of these three
remaining markets. Fujitsu should have product available soon after the
launch. All of these vendors will be using Qualcomm's MSM 3000 chipset.
CDMA Handsets
Qualcomm has a strong presence in CDMA handsets. We estimate the company's
1998 CDMA handset market share was 26%. In touring the handset 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 last month). Customer demand
(Airtouch, Primeco and Sprint are the largest customers) is for the 820,
2700 and 1920 in that order. These three phones are due to be upgraded to
the MSM 3000 chipset with in the next several weeks. This upgrade should
give the phone better price and performance characteristics. The new thin
phone is currently being run in pre-production batches and should be
manufactured in volume by the summer. The PDQ is also being manufactured
in pre-production batches and is anticipated to be a low volume product.
The "Q" phone production was clearly at low levels. During our visit there
were no new "Q" phones being manufactured. There were several batches of
"Q" phones being reprogrammed for markets outside the U.S. primarily to
Latin America. New phones will manufactured as demand warrants. Due to
demand, handset shipments will be up sequentially in Q2, but, due to price
cuts, revenues will be down sequentially. We are forecasting $422 million
in handset revenues in the quarter, down from $465 million in 1Q.
This was our sixth visit to the handset facility (our last one was
approximately one year ago). One significant improvement we noted from our
last visit was the incorporation of certain automated process in the final
assembly and test area (which historically has been very labor intensive).
The company has incorporated an automated system for performing certain
tests and software loading for the phones. Payback on this system is less
than eight months. Further, the lines are set up to run any phone down
any line with minimum modification.
Handsets represent 50% of our FY99 revenue forecast. 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. Qualcomm continues to ramp the production of
IS-95 CDMA handsets and anticipates reaching 1 million in monthly capacity
by year-end. Management's goals are mid-20's gross margins and low double-
digit operating margins.
We note that Qualcomm's $300 million contract with Great Wall to supply
CDMA handsets is still intact. Should China move forward with IS-95 CDMA
deployments, it would likely mean additional handset business for Qualcomm.
Royalties
There has been some confusion regarding Qualcomm's royalty revenue due to
the announced agreement with Ericsson. For IS-95, there has been no change
in Qualcomm's royalty receipts. Ericsson will pay Qualcomm a royalty to
manufacture IS-95 CDMA handsets. Further, the future royalty stream into
Qualcomm is the same, regardless of whether the technology being deployed
is WCDMA, CDMA2000 etc. At some point in the future, Qualcomm will pay
Ericsson a small royalty for their patents in WCDMA. We believe this
royalty will be paid when Qualcomm manufacturers multi-mode handsets for
3G.
Financials
The company has approximately $400 million in vendor financing obligations
over the next three years (99-01). The company will need to raise some
money in 1999 for vendor financing obligations. We estimate that Qualcomm
will generate between $250 million and $500 million from the sale of its
infrastructure division to Ericsson. In Q2, we estimate that the company
will incur write-offs of between $100 million and $300 million for certain
assets that were not acquired by Ericsson. Previously, the cost being
incurred each quarter to accommodate new hires was quite significant. The
combination of layoffs in January and pending sale of the infrastructure
division to Ericsson has virtually eliminated new hires. As a result,
capital spending should decline meaningfully.
Our new model assumes increased CDMA subscriber growth reflecting a strong
1998 and improved prospects given the recent settlement with Ericsson and
potential for IS-95 in China. Further, we are reducing our revenue
forecasts to reflect the sale of the infrastructure division to Ericsson.
Due to the combination of continued strong ASIC and handset demand, plus
the cost savings due to the sale of the infrastructure division, we are
increasing our 2Q, FY99 and FY00 revenue and EPS estimates to the
following.
2Q was $897 million and $0.58, is $927 million and $0.60,
FY99 was $3,896 million and $2.66, is $3,787 million and $2.77,
FY00 was $4,530 million and $3.55, is $4,002 million and $4.35
We are reiterating our "Buy" investment rating on the shares and are
increasing our price target to $130 (about 30x our FY00 EPS estimate of
$4.35). |
