Qualcomm looks like a good call

5/5/2008


By the end of this year, Qualcomm ($44; NASDAQ: QCOM) should be able to jettison some of the baggage holding back its stock. The company is embroiled in disputes over royalty fees paid for use of its patents, particularly by one of its largest customers, Nokia ($30; NYSE: NOK). In March, the combatants agreed to consolidate a host of lawsuits into one case to be heard later this year and likely to be decided by year’s end.

Uncertainty about the legal disputes has weighed on the stock, which has jumped around without accomplishing much over the last nine months, though the upward move seen in recent weeks is encouraging. But through the distractions, Qualcomm has continued to post solid earnings growth. Per-share earnings excluding special items and stock-based compensation rose 23% in fiscal 2007 ended September and 14% in the six months ended March.

Consensus estimates project growth in per-share earnings of 5% in fiscal 2008 ending September and 14% in fiscal 2009. Costs have risen sharply in recent quarters, but the company still seems capable of topping Wall Street’s expectations. Qualcomm is a Buy and a Long-Term Buy.

Chips and patents
While the U.S. economic slowdown has sparked fears of a decline in demand for microchips, Qualcomm should benefit as cell-phone users worldwide transition to third-generation technology, which allows for faster downloading of video, music and other data.

The company generates 90% of its revenue from cell-phone chipsets and license royalties paid by users of its intellectual property. Most of the rest of sales (9%) comes from mobile logistics and navigation services.

Qualcomm sells its microchips for use in mobile phones and wireless infrastructure around the globe. Such products accounted for 59% of fiscal 2007 revenue. Growth should remain strong as networks in the U.S., Europe, and Japan convert to third-generation technology and emerging markets expand and upgrade their infrastructure.

Intellectual-property licensing — royalty payments from makers of handsets and other communications equipment — accounts for 31% of revenue but 54% of operating earnings. Legal disputes with Nokia stem from Nokia’s shipping of handsets without paying royalties. Barring a disastrous court loss, which seems unlikely, Qualcomm shares should benefit. Any resolution will reduce uncertainty.

Strong growth potential
Though the court case may distract investors, Qualcomm’s long-term fundamentals appear solid. Demand for higher-functioning cell phones remains strong, as subscribers upgrade phones and carriers increase sales of third-generation products. While customers adopt third-generation wireless technology, Qualcomm is already preparing a portfolio of fourth-generation technology slated for release from 2011 to 2015.

Qualcomm shares have risen 11% this year, compared to a 5% decline in the S&P 500 Index. At 20 times the per-share earnings of $2.21 expected over the next year, Qualcomm trades below its five-year average forward P/E ratio of 24. An annual report for Qualcomm Inc. is available at 5775 Morehouse Drive, San Diego, CA, 92121; (858) 587-1121; www.qualcomm.com.


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