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.
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.
Optimistic – For the next 5 years owner earnings grow at 20% annually, then that rate falls to 10% annually for another 5 years, and finally to 3% annually in perpetuity.
Quite Optimistic – For the next 5 years owner earnings grow at 25% annually, then that rate falls to 12.5% annually for another 5 years, and finally to 3% annually in perpetuity.
To value the company under these different scenarios I’ll do a discounted cash flowcalculation, using a discount rate of 12% and 15% to define a fair value range. The results are in the table below.
| Scenario | Low-end | High-end |
|---|---|---|
| In-line | $50.47 | $63.70 |
| Optimistic | $60.34 | $78.38 |
| Quite Optimistic | $72.99 | $97.37 |
The current market price of about $66 is just above the high-end of the in-line scenario. Which scenario is the most realistic? It’s hard to say. Technology changes fast, and trying to predict things 5 years or 10 years out is basically just guessing. It looks to me that QUALCOMM, Inc. (NASDAQ:QCOM) is probably roughly fairly valued. It’s not as cheap as many people seem to think, but it’s also not significantly overvalued. The stock would look a lot better to me in the $50’s than it does now.
Fierce competition
Qualcomm faces competition of two different types. First you have companies like NVIDIA Corporation (NASDAQ:NVDA), which use the same ARM architecture in their chips as Qualcomm does. NVIDIA has the Tegra line of mobile processors and recently announced the newest version, the Tegra 4. Along with this NVIDIA announced the Tegra 4i, a version which has integrated LTE, in a direct attempt to knock Qualcomm off of its dominant LTE market position.
From an investment perspective NVIDIA is about as cheap as cheap gets. With a stock price of just over $12 per share, net cash of $6 per share, and free cash flow of about $1 per share, NVIDIA Corporation (NASDAQ:NVDA) is trading at completely irrational levels.
On another front Qualcomm faces the Intel Corporation (NASDAQ:INTC) juggernaut. Intel uses a different architecture in its chips, x86 instead of ARM, and has as of now very little presence in the mobile market. But Intel will power many of the Windows-based tablets coming to the market, and if these gain any traction with consumers Intel could see its market share rise considerably.
Intel has been spending a huge amount on capex in the last couple of years, $10.7 billion in 2011 and $11 billion in 2012, as the company races to build faster and more efficient chips. This is almost 10 times as much as Qualcomm spends annually, so Intel Corporation (NASDAQ:INTC) should not be counted out. Intel also spent $10 billion on research and development in 2012 compared to Qualcomm’s $3.9 billion, even though Qualcomm’s market cap is about 10% higher than that of Intel. Intel is spending a lot of money in an attempt to be competitive here, and if I were QUALCOMM, Inc. (NASDAQ:QCOM) I’d be very afraid.
Intel Corporation (NASDAQ:INTC) also pays a 4.2% dividend yield, which is about the highest you’ll find out of the big tech companies these days.
The bottom line
Qualcomm is more expensive than it appears. I think at best the stock is fairly valued and I’d want to see it fall into the $50’s before even considering it. The company faces increasing competition from the likes of NVIDIA Corporation (NASDAQ:NVDA) and Intel, and it’s unlikely that they’ll be able to maintain their mammoth market share for all that much longer. I don’t think the growth justifies the price at $66 per share, and I’d wait for a significant pullback before buying any shares of Qualcomm.
Timothy Green owns shares of NVIDIA. The Motley Fool recommends Intel and NVIDIA. The Motley Fool owns shares of Intel and Qualcomm.
