QualComm: More on Valuation

By Vijay Nagarajan, Guest Author

As I mentioned in my last article, QCOM has been pro-actively chasing more silicon with diversification efforts and aggressive development. There are a some key attributes to note –

• All the extra growth comes from its semiconductor business. Though at lower margins, it is a no litigation, no risk income.
• With more silicon market share, there is a more sustained growth opportunity. Standards come and go, patents expire but the semiconductor business will stay. A wider footprint is inevitable for future growth. This makes the growth model more rigid than the mobile IP dominated scenarios.

The figure below represents the revenue projections for each of the positives discussed in QualComm: Chasing More Silicon.

We see that each of these events raise the growth by about 3%. The valuation of the QCOM stock with Gobi in the picture goes up to $52. Motorola coming back to its fold can also raise valuation to the same number. The 3GPP market share growth puts the share value at $50.60. with these three events being mutually exclusive, their simultaneous materialization (discounting all negative events) makes it $60.40.

So, if we superpose these events and likely scenarios on the company’s earnings, we get outliers at $28 and $60. But if I were to further pick a sequence of events from this list I have created, then I will go with

• Domino Effect
• Gobi
• 3GPP market share growth

This yields a composite share valuation of $44.60. I am willing to bet this much for now. To me, more than the number itself, it is the strength it represents. While I will conclude this series in my next piece, with all these details in place, I will pose Ms. Mitra’s question back to her –

Is QCOM still a stock to short?

Note on the valuation: Cash flow was obtained as 60% of the operating profits by projecting historical data. Operating margins were computed for each scenario and year based on the QTL/QCT revenue mix. Discount was assumed at 8%.

This segment is a part in the series : QualComm

Comments

Hi Vijay-

Thanks for sharing your QCOM valuation thoughts in your continuing series of interesting QCOM articles.

Wondered if you would share some more detail behind your financial model (see list below). These are the metrics I’ve uncovered so far in your many articles>>>

Snips>>>>

• The overall revenue will potentially double from an estimated $8.8 billion this year to over $17 billion in 2012, with a CAGR of 14.23%.

…+ QTL- $10
…+ QCT- $ 7
…= Tot- $17

• The graph below represents QualComm’s revenue potential if it is still able to extract close to 6% of handset ASP on the 3GPP handsets while not exceeding 25% of the corresponding chipset market share

• With sustained growth and about 20% R&D budget (same as 2006), QualComm will potentially see their operating margins grow by about 5%.

……………………………2012
QTL-
..handset units
….WCDMA
….CDMA
..handset ASP
..Royalty rate………0.6% ???
..Oper Mgn
QCT
..Chipset share
….WCDMA…………..25%
….CDMA
..Chipset ASP
..Oper Mgn
Other Rev
..QWI, etc
..Interest / investment Income
Tax rate
Net Income
Shares Outstanding
EPS

Thanks again, Jim M.
….(minor point- QCOM spelling, QUALCOMM (total acronym), or Qualcomm, not QualComm)

jim mullens Wednesday, November 7, 2007 at 10:57 AM PT

Hi Vijay-

A couple more comments on your QCOM “More on Valuation”-

“We see that each of these events raise the growth by about 3%. The valuation of the QCOM stock with Gobi in the picture goes up to $52. Motorola coming back to its fold can also raise valuation to the same number. The 3GPP market share growth puts the share value at $50.60. with these three events being mutually exclusive, their simultaneous materialization (discounting all negative events) makes it $60.40.”

In these three scenarios you show QCOM’s revenue increasing to between $17 B to $20 B in 2012 ( from about $9 B in 2007) while valuing the share price at $60.40 at the high end. You appear to be using DCF formulas to arrive at your valuation; a common approach used by the analyst community which discounts the future revenue (cash flow) to a present value (what one would pay today for tomorrow’s growth).

I also like to also look at the future share price (in 2012) based upon those same assumptions, without discounting it back to present value using DCF. I believe this gives me more of a sense of what the real future rewards are, not masked (obscured) by the more conservative DCF approach. In other words, I might not get to excited about owing QCOM if I think its only worth $45 to $50 based on DCF, but at $140 – $180 it’s an entirely different story.

QCOM $/share – 2012

………………………..2007…………2012

Revenue…………….$9.0…………$17.0B
Net Income………….3.4…………..12.2
Shares Out…………..1.7…………….1.7B
EPS………………….$2.03…………$7.15
.
PE…………………….20.2……………..20………….25
$/sh…………………$41.00………..$143……….$178

Jim M

jim mullens Thursday, November 8, 2007 at 7:49 AM PT

Jim,

Sorry for a delayed response. With respect to the model parameters, it is a bit more complicated than those abstracted in your request. For example, the operating margin is a function of the ratio of QTL and QCT revenues which varies from scenario to scenario. However, let me give you some that are more straighforward –
Shares outstanding: 1.67 billion
CDMA share: 80%
Chipset ASP ~$24
Handset ASP ~$ $200 for WCDMA/HSDPA, $125 for CDMA/EV-DO
Royalty rate: ~5% aggregate
You can obtain handset unit ballparks from the graphs in earlier articles. Hope this helps.

With respect to your second comment on valuation, I do wish to emphasize that my analysis is not entirely a DCF-based analysis. Most other valuations are based on historic data that is projected over next 5-10 years. As you can see, I have used more of an event-driven valuation based on industry events. In essence, a lot of the valuation parameters themselves change based on the combination of scenarios that I run. However, I will not agree to your point of not using a discount at all. Here is why: If I take my money today and put it in a bank security in India, I can get around 8% or so. What I am looking at from company stock is whether I can get over and above this rate. If QCOM gives me less than this 8%, I would rather pick a lower risk security, right? So, I firmly believe that a share’s inherent value will be determined by its relative strength with respect to other performance indices in the market.

With respect to your numbers, I think the net income assumed is very high. You are implicitly assuming that the operating margin is at 71% which is essentially double of the current margin of about 35%. With the QTL/QCT mix in 2012, the margin may be around 40% which will bring the net income down to $7 billion which with a 20 PE will get you around $80. Incidentally, the way I arrive at my current valuation is not as simple as this.

Vijay Thursday, November 15, 2007 at 7:27 PM PT