Qualcomm Inc (QCOM)

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Qualcomm: Top of the Wireless Food Chain(I)
S&P likes the stock since the company's patents in mobile telecom technology give it an edge over rivals as global demand picks up

We at Standard & Poor's Equity Research Services view Qualcomm (QCOM; buy; recent price: $63.50) as the best in its class, with one of the most attractive business models in the telecommunications industry. In many ways, we see parallels to the success Microsoft (MSFT; buy; $26) enjoyed in the last decade. Advertisement

Qualcomm has a unique position, thanks to its intellectual property from designing code division multiple access (CDMA) for the mobile wireless industry. Its patents' strength have enabled the outfit to receive high-margin license royalty fees from all users, handset and infrastructure suppliers, as well as service providers that use CDMA for software-enabling applications.

In addition, Qualcomm is the leading fabless semiconductor concern, with more than 98% of the worldwide market for CDMA chipsets. Fabless means it designs and upgrades its portfolio of CDMA chipsets and then outsources the manufacturing to foundries operated by IBM (IBM; buy; $94) and Taiwan Semiconductor Manufacturing (TSM; $10.80).

CASH PILE. Having foundries in each major region of the world is what San Diego-based Qualcomm is planning, with Europe the next major target as the Continent's telcos begin to upgrade for third-generation (3G) technology known as WCDMA (wideband code division multiple access) or UMTS (universal mobile telecommunications systems).

Plus, Qualcomm generates substantial operating cash flow to meet capital requirements, make strategic investments, and pay a dividend on common shares. As of Dec. 31, it had approximately $5.4 billion in cash and cash equivalents, or 61% of its total assets, with long-term debt under $130 million. As its Board of Directors declared a 43% hike in its annual cash dividend, to 40 cents per share, we anticipate that the stock may become more attractive to a broader group of mutual funds that seek growth and income in their portfolios.

Aside from its $5.4 billion in cash equivalents and nominal long-term debt, the 25% sales growth and net margins near 30% that we expect for 2004 are favorable drivers to boost higher earnings growth and bigger p-e gains for the shares.

A CLOSER LOOK. Our 12-month target price of $80 is based on discounted cash flow and forward price-to-sales and price-to-earnings valuation metrics. (Our model assumes a weighted average cost of capital of 12.48% and a terminal growth rate for free cash flows of 7% after year 15. We believe our assumption of mid-20% cash-flow growth for the next five years is reasonable, followed by a gradual slowing to 8% in year 15.) The shares trade near peer levels on a 2004 p-e multiple basis, and we would buy the stock based on our view of a strong company outlook.

Digging deeper into the numbers, let's take a look at Qualcomm's major products and services. It reports results in four operating segments: CDMA technology, technology licensing, wireless and Internet, and strategic initiatives.

The CDMA segment, which accounted for 61% of total sales in the December quarter, provides integrated circuits and system software to many of the world's leading wireless handset and infrastructure manufacturers. After shipping 32 million chipsets in the seasonally strong December quarter, Qualcomm raised its forecast for the March quarter to 31 million to 32 million units, from a previous range of 29 million to 31 million units.

CHIPS AHOY! The comparisons get easier in the June and September quarters, as Qualcomm should not experience the same weak demand as last year, when SARS and an inventory glut in China reduced chipset shipments. We're forecasting 123.5 million chips to be shipped in fiscal 2004, up 23.5% from the prior year.

Dominating the CDMA market, Qualcomm has developed a family of chips called mobile station modems (MSM) for 2G and 3G wireless handsets. Average selling prices (ASPs) are stable to slightly higher as it introduces higher functioning chips for audio, video, camera, and graphics capabilities. By 2005, Qualcomm's enhanced multimedia and graphics chipsets will allow camera-ready phones to deliver images of up to 4 megapixels.

In November, 2003, Qualcomm was selected by 13 global manufacturers for its integrated chipsets and software to deliver a wide variety of enterprise and consumer wireless devices to support WCDMA (UMTS) markets. In February, 2004, Huawei Technologies and ZTE Corp., two major Chinese equipment suppliers, selected Qualcomm's MSM6250 MSM chipset and system software to enable cost-effective, data-enhanced handsets for the WCDMA (UMTS) market.

http://www.businessweek.com/investor/content/mar2004/pi20040312_1829_pi044.htm