Mobile telecommunications continues to remain a strong industry as worldwide wireless connections are expected to continue growing at 100-200 million per quarter for at least the next two years. Device sales per connection have grown at 15-20% year-over-year since falling significantly in 2009 following the calamity in the financial markets and are beginning to exceed historic, pre-recession levels of ~$7.50 per connection per quarter. In addition to recovering financial markets, growth in device sales has been led by growth in emerging markets, greater 3G/4G adoption, and greater device turnover from leading 3G/4G device manufacturers (most notably Apple Inc. (NASDAQ:AAPL) and Samsung). While it is difficult to quantify, I am anticipating continued growth in dollar sales per connection of ~10% per year through 2014 based primarily on greater adoption rates in emerging markets.
QUALCOMM, Inc. (NASDAQ:QCOM) is poised to capitalize on this trend through their line of MSM (multi-station modem) products. Over the same period when device sales have grown 15-20%, MSM shipments have increased at 18-22% and are expected to continue growing at 15% per year through 2014. This increase in shipments should translate into year-over-year equipment and services revenue growth of 21% and 12% in 2013 and 2014, respectively. This is a small expectation when considering that in both 2011 and 2012 the company saw increases of approximately 34% year-over-year.
Additionally, the last two times the company’s inventory turnover ratio fell to near 3, Q4 2008 (3.11) and Q2 2011 (3.05), it was followed by increases in quarterly MSM shipments of 30% and 36% within the next 6 months that continued to grow from those new levels quarter-over-quarter. Inventory turnover in Q3 2012 was 3.12 and Q4 2012 MSM shipments were up 30% versus Q3 2012 at 182 million. Estimates here are based on average MSM shipments of 170 over the next 3 quarters providing evidence that these estimates are actually quite conservative.
While revenue has continued to accelerate, the company has quietly hidden ongoing margin contraction. Despite an increase of nearly 25% in the average sale price of MSM products since 2009, the gross margin has fallen from 70% to 62% over the same period. The company has managed to keep net margins relatively flat by reducing their investment allocation towards research and development and cutting back growth rates in their sales force. As a percent of revenue, these expenses have fallen from ~36% to ~29% since 2009; however, on a pure dollar basis these expenses have actually risen approximately 68% suggesting that sales growth is simply outperforming opportunities to invest in these areas. While I do believe there is some expense management occurring in order to maintain net margins, the company is continuing to invest in the future and margin contraction should be expected as the company expands its product line into relatively less profitable areas.