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QUALCOMM, Inc. (QCOM): This Chip Giant Is More Expensive Than It Appears

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If you own a smart phone there’s a good chance that a chip from QUALCOMM, Inc. (NASDAQ:QCOM) is powering it. The company’s Snapdragon line of processors show up in a huge number of devices, and Qualcomm’s market share is somewhere around 50% in the smart phone chipset market. The explosion of mobile devices has led Qualcomm to almost double its revenue in just two years, recording $19.1 billion in sales in fiscal 2012. And with more and more smart phones and tablets sold each year, in the US and increasingly in the emerging world, it looks like Qualcomm’s meteoric growth will continue for quite some time.

QUALCOMM, Inc. (NASDAQ:QCOM)

A growing cash pile

Along with the growing revenue comes a pile of cash which keeps getting bigger. At the end of the most recent quarter QUALCOMM, Inc. (NASDAQ:QCOM) had $28.37 billion in cash and investments, or about $16.20 per share. This cash represents just shy of 25% of the total market capitalization. Practically what this means is that all of the fundamental ratios, P/E and the like, should actually be 25% lower than the values typically reported. With a share price around $66, backing out the cash suggests that the market is valuing all of Qualcomm’s future earnings at about $50 per share.

This cash horde allows for Qualcomm to return profits to shareholders at an increased pace. The company bought back $1.3 billion in shares in fiscal 2012, although almost all of this went to negate the dilutive effect of stock-based compensation. This buyback, then, did nothing for shareholders except create the illusion of shareholder-friendly policies. QUALCOMM, Inc. (NASDAQ:QCOM) has been raising its dividend, with a recent 40% hike to $0.35 quarterly, although the yield of 2.1% after the increase isn’t particularly attractive.

A look at profits

Since 2003 Qualcomm’s revenue has grown at an annualized rate of 19.1% while net income has grown at an impressive 24.9% rate. In fiscal 2012 net income came in at $6.06 billion compared to a free cash flow of $4.71 billion. That’s a big difference, and using one or the other will affect the valuation of the company considerably. Instead of using either I’ll calculate the owner earnings, a concept created by Warren Buffett. Since Qualcomm spent a huge amount of money to offset the effect of stock-based compensation in 2012 I will count this as an expense. If the company hadn’t spent this money then the number of shares would have increased and yielded the same result, but adding back stock-based compensation and using the post-buyback share number is dubious at best.

Before subtracting the capital expenditures I arrive at a value of $5.23 billion. Capex rose considerably in 2012 to $1.28 billion, and my expectation is that this will be the new norm as competition increases, so I’ll use this value directly. This leaves owner earnings of $3.95 billion in 2012, or $2.25 per share. Note that this is significantly less than the EPS of $3.51 reported for 2012.

This puts the price/owner earnings ratio after backing out the net cash at about 22, compared to a P/E ratio of 14. In the case of QUALCOMM, Inc. (NASDAQ:QCOM) the net income makes the company appear cheaper than it really is, largely because stock-based compensation is not counted as an expense when calculating GAAP numbers.

How much is Qualcomm worth?

The average analyst estimate for 5-year annual earnings growth is about 15%, which doesn’t seem unreasonable for a company like Qualcomm. I’ll value Qualcomm using three different scenarios to get a good sense of the intrinsic value of the company:

In-line – For the next 5 years owner earnings grow at 15% annually, then that rate falls to 7.5% annually for another 5 years, and finally to 3% annually in perpetuity.

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