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Qualcomm's China Problems Require Investor Patience
12/13/2014 7:30 am EST
Problems with China are to blame for this global semiconductor company's shares being up just 0.73% in the last 12 months and why they could also suffer in 2015, but MoneyShow's Jim Jubak highlights how prospects look brighter in the long-term.
Qualcomm (QCOM) has a China problem. A big China problem.
China is the reason that the shares are up just 0.73% in the last 12 months. And why 2015 could well turn out to be another dead year. The issue for this stock is whether the risk of another year of dead money outweighs the upside long-term potential and whether or not you believe that company's estimate/wish that at least some of the company's China issues will be over in 2015 (or so).
In its recent guidance for fiscal 2015 (the company's fiscal year ends in September), Qualcomm guided for revenues of somewhere between $7.3 billion and $8.3 billion.
The reason for that big spread is uncertainty over China.
Chinese makers of handsets did not pay Qualcomm royalties on sales of roughly 215 million units in fiscal 2014 and the company estimates that the non-payment problem will rise to upwards of 300 million handsets in fiscal 2015.
The root of the problem is an investigation by China's National Development and Reform Commission looking at the question of whether the relationship between Qualcomm's chip sales business and its technology licensing business violates China's laws on competition, rebates, and fair and reasonable links between chip purchases and technology licensing. (Before you jump to the conclusion that this is just another example of China using its trade laws to advantage domestic companies-which it is to a degree-you should note that US and European Union regulators are looking at similar issues at Qualcomm.) Chinese companies have used the investigation as an excuse to postpone licensing deals, to delay payments to Qualcomm, and to under-report sales. (One of the reasons that I like Qualcomm as a stock and have put it in my Jubak's Picks portfolio is that because of the company's ownership of key parts of wireless technology (the code-division multiple-access (CDMA) part), Qualcomm collects royalties from the sale of phones that use that technology even if they don't use Qualcomm's own chips).
From a long-term perspective, Qualcomm's prospects look much brighter. The company is introducing its fifth generation LTE chip, when most competitors are working with first generation technology. As network operators try to get more performance out of available spectrum and introduce more complex services to grow revenue, Qualcomm's technology edge becomes more valuable. That's likely to give Qualcomm about 45% of the wireless chip market in the long-term, Credit Suisse estimates.
Which doesn't mean that the company doesn't face challenges even outside of China. Handset makers looking to duplicate the features of top-end smart phones, but at much lower price points, are looking for chips that deliver more performance for few dollars or renminbi. That will keep average selling prices falling at low single digit rates.
On the upside, Qualcomm sees 15% annual growth in 3G and 4G devices and a doubling of the installed smartphone base to 3.4 billion from 1.6 billion units.
The company is also making a big push into the automotive market and has signed 40 agreements with automotive original equipment makers. Qualcomm estimates that 60% of new cars shipped in 2018 will be mobile phone connected.
And, finally, Qualcomm is targeting the Internet of Things. The company sees 200 million such systems by 2018 with opportunities in chips that connect these devices to the Internet.
Because of the near-term problems in China, I think you may have to wait a while to see those long-term prospects reflected in the share price but I think your patience will be rewarded.
I calculate an $85 a share target price for these shares by December 2015.
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