Qualcomm - QCOM (Hold)
Thanks to @Fotis for the suggestion to take a look at the mega chip manufacturer Qualcomm. This isn’t a company I have looked at before but it’s an exciting firm and one you might not have heard of, but you have likely engaged with their products and solutions.
Qualcomm is a specialist in network technologies, think 4G and 5G, for mobile and smart devices. They also get involved in the hardware as well as the policy side of wireless networks.
What Do They Do?
Qualcomm is split into three different divisions.
Source: Qualcomm Investor Relations
QCT develops and supplies circuits and software based on CDMA, OFDMA for mobile devices. We are talking smartphones to gaming devices, broadband gateway equipment to the Internet of Things (IoT) devices. Aside from their biggest market which is smartphones, smart and driverless cars will be a massive growth market for this segment.
This is the biggest revenue driver right now and the biggest focus of the business. Selling chips for the next generation of phones, e.g. 5G enabled phones with fast chips with integrated networks. They also offer network cards and software for Wi-Fi, Bluetooth, NFC, and even help support location and data services.
Source: QCT Information
QTL grants licenses to use portions of Qualcomm’s intellectual property, which includes patent rights essential to the manufacture and sale of some wireless products. Their heavy investment into the standards and processes in the wireless space, along with a rough and tumble league of lawyers, mean they can lockout competitors or collect IP license fees from rivals.
While a declining area, due to the growth of 4G over the years, we can expect this to increase as 5G devices increase in popularity. However, new competitors with their IP mean this isn’t going to be lucrative forever. This does force other companies to invest in their R&D creating an arms race.
It’s worth noting that Qualcomm has an advantage due to its vertically integrated business model. Versus other network firms who do not own the IP behind the technology, or even the manufacturing process.
Source: QTL Information
QSI looks after and makes strategic investments. This is different from the groups R&D which belongs to each sub-division. Here Qualcomm invests in different companies involved in automotive, IoT, mobile, datacentres, and healthcare.
This allows them access to the inside track with early-stage companies which might be moving faster in specialist areas. This is an easy way to acquire new licences or customers, depending on the focus of the company.
Source: QSI Information
What Are The Risks?
Qualcomm is a competitor to Huawei. The two has slightly different approaches but are heavily influenced by each other.
Huawei has secured 5G contracts in the UK, while this helps the rollout of 5G which enables 5G enabled devices (where Qualcomm can sell the chips) they are missing out on the available infrastructure plays.
There is also the bet on 5G delivering on the promise. Having faster internet on devices is only a small part of the deal. The real cherry is the new devices and technologies that 5G enables. For example, why do complex processing on your phone when doing digital enhancements to a photo (privacy concerns to the side for a moment) when it can be done by cloud edge computing? Fast, lean, cloud-based functions which your device can rely on to do complex processing without it being a drain on your device. Driverless cars where the central processing is done remotely due to the availability and speed of 5G. You are no longer limited to the hardware of the device you deploy with.
Source: Forecast of the 5G chipset market size worldwide from 2019 to 2027
Source: Number of wireless subscriptions by generation worldwide from 2010 to 2023
While the 5G growth and adoption, figures look extremely promising. Qualcomm does have an additional risk which isn’t shared by all its competitors.
The vertical integration of its business is a blessing and a curse. Any manufacturing or logistical issues encountered will be felt throughout the whole value change. This does make them slower to innovate against their adversaries who don’t have the same constraints.
We also have the different legal issues Qualcomm has, having just ended with a successful payout from Apple over the use of their IP. While they are the largest smartphone chip producers they are not loved by their customers. Making them vulnerable in the long run to a more customer-centric business. This is where their licence division focused not on making money but locking out competitors and keeping the barrier to entry as high as possible.
Qualcomm is also extremely sensitive to a US/China trade war. Which is sadly brewing once again. If Trump is to be elected for another four years, this will put the pressure back on for Qualcomm as it damages it’s manufacturing plans.
Source: Genuine Impact
Qualcomm is a very high-quality company. They have excellent profitability, bringing in $24.7bn in revenue and converting an impressive 18% into profit.
They also have a strong grasp over their debt due to the high cash conversion.
Source: Qualcomm 2Q 2020 Results
$2.5bn of short term debt is normally a warning sign, but with $8.4bn cash on hand (plus other cash-like assets which I haven’t included), this is meanly cash flow control.
Source: Qualcomm 2Q 2020 Financial Results (Summary)
In terms of a dividend, this might be an attractive business for you. With 72.5% of earnings paid back to investors! They sure know how to keep you sweet. A 3.2% dividend yield is impressive, while not groundbreaking, but can be sensitive to the risks mentioned before.
When it comes to buying Qualcomm it’s very expensive to pick up right now. Nothing about the price versus balance sheet, or income, or even against the cash flow is attractive right now.
Even when we take target share price figures into account and future growth, the company is still overpriced. There is a lot of optimism around the 5G explosion with little risk priced in. This means negative news or slowdowns (which the trade war can easily bring back) we can expect to slash the price.
Source: Genuine Impact
We are also seeing an unimpressive, but not concerning view from the sell-side analysts. We are seeing analysts change from a buy rating to a hold one.
I can understand why, with so many unknowns in the immediate future, and trade war 2 electric boogaloo on the horizon, we can expect some discounting of the share price yet.
So Why A Hold?
There is a lot of upsides here, I see strong future growth and a high-quality company with enough cash reserves to fight off the competitors and keep winning big deals.
When it comes to 5G these are the guys to watch, while slower than their peers they have the vertical integration few companies can dream of.
However, we are likely going to face some short term volatility. This is a stock to watch, if you hold it you won’t have any issues with pound cost averaging, but if you are looking to enter this is one to add to the wishlist and keep monitoring. We have political, manufacturing, and competition risks to manage right now unless you are happy to lockin and get those dividends, this doesn’t feel like one to rush.
Either wait for the next earnings or until the share price makes this slightly more attractive.
Let me know what you think! Any suggestions for companies or funds to look at next, or any points you disagree with. Love to hear your feedback!