http://seekingalpha.com/article/3650366-qualcomms-results-were-abysmal-investors-should-evacuate
Summary
I anticipate a pattern of weakening fundamentals driven by weakness in the product portfolio, falling ASPs, and market share erosion.
Qualcomm has to compete on price given the commodity-like nature of Chinese competitors, and may lose key designs at the high-end of the baseband modem space.
These factors in conjunction with weakening smartphone growth will weigh on margins. Efforts to reduce cost won't offset the negative impact from lower pricing.
Guidance was underwhelming, and non-GAAP EPS is expected to decline by more than 30% in the next quarter.
At this point, investors need to reallocate towards safer/better alternatives (Intel and Nvidia).
Qualcomm (NASDAQ:QCOM) struggled this quarter, partially because of bad guidance, but also due to uncertainty with the company's product strategy. Initially, I anticipated that these patterns would eventually stabilize, but forecast assumptions on mobile smartphone growth proved to be inaccurate, as forecasts continued to adjust lower over the trailing two-year period. Investors/analysts started to become more conservative on their expectations for revenue/profit growth, and for good reason. The combined impact of falling ASPs, heightened competition, and slowing industry growth puts pressure on future earnings and revenue. In other words, there are much better options in the semiconductor space.
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Source: Creative Commons
The company continued to make progress on its strategic realignment plan. I'm not a huge fan of spinning the company into two separate entities, as the licensing business is mostly driven by ongoing R&D in the QCT segment. Qualcomm could in fact split into two separate companies judging by their willingness to create short-term shareholder value, but what has proven to work for different companies within the technology space might not work for Qualcomm. The two businesses (QCT and QTL) are more interlinked and the strategic value from separating the two entities seems limited.
Qualcomm is using up its domestic cash reserves to hastily buyback shares, and is using up its share buyback and accelerated buy back authorization despite its dwindling cash pile within the United States. Does the company start bringing back the foreign cash, or do they buyback shares from offshore accounts? I'm not really sure, and further visibility into this issue would be helpful. The company didn't elaborate on their cash position, but assuming they raise debt they're going to defer taxes on the offshore cash, or they may bring the cash and risk taxation. Apple (NASDAQ:AAPL) raised capital in Japan recently to start buying back shares, so maybe a foreign bond auction is in the works over at Qualcomm. Qualcomm had $5.3 billion in domestic cash in Q3'15 and is planning to repurchase an incremental $10 billion in stock by Q2'16. A huge chunk of that is funded by free cash flow as they plan to return 75% of free cash flow, and lower operating expenditures to meet its current cash constraints.
The core issue has been falling device ASPs on reported device sales. Qualcomm is expected to report weaker sequential comps. Qualcomm's revenue is likely to be at the high-end of its outlook range, but even at the high-end Qualcomm will report either muted growth or sequential weakness. The range in revenue is mostly driven by the timing of license agreements with key Chinese OEMs.
An analyst on the conference call attempts to clarify this issue about timing, and the impact on revenue:
It seems like you've been holding your outlook for the global market flat to even up over the last few quarters and yet you've been stepping what you're capturing down, which implies to me that your ability to get paid in China has been getting even worse and worse after you signed the NDRC settlement, which to me just doesn't make a lot of sense. Why would your ability to get paid get worse after you settled with the government? - Stacy Rasgon from Sanford C. Bernstein
As I mentioned, we've got a number of agreement signed up, but there are still a handful of significant ones that are under negotiation. So what's played out through the course of this year really are a few different things. One is we have made slower than expected progress in these negotiations which means that we're not getting paid on as large amount of the 3-mode volume that we expected. And that's really a negotiating dynamic from our perspective. Once we get these agreements done, we will get paid. Derek K. Aberle (President of Qualcomm)
Assuming, Qualcomm does negotiate and close more transactions in China we get to flat or slightly negative revenue. However, ASPs on devices are expected to decline even further, as more OEMs are transitioning their device mix down into the mid to low-tier in emerging markets. Qualcomm's growth primarily hinges on emerging market adoption. While regional dynamics answer some of the issues, there's no denying that competition is also weighing on pricing dynamics. As such, Qualcomm is starting to realign its pricing to be more competitive. It's offsetting some of that impact through cost reductions. This transitional period has weighed on shareholders. Quite frankly, the main theme has been execution risk for the past couple quarters. The board and management team does overcompensate for this, as there's not much agency risk, but the reactionary nature to weakening market/business dynamics raises questions about Mollenkopf's ability to strategically position Qualcomm to succeed in the mobile handset space.
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Source: Qualcomm
The company's guidance for non-GAAP diluted EPS was $.80 to $.90. Assuming the high-end scenario occurs, we're working with $.90 in non-GAAP EPS, which is below consensus estimates at $1.08. Basically, they're off consensus estimates by a full 16.6% in their best case scenario, and year-over-year non-GAAP earnings is projected to decline by 36.5% (again this is best case scenario). That's pretty bad, folks.
In fact, the stock's reaction to earnings in the after hours seems justifiable as it fell by 5% (at the time of writing). As of early Thursday morning, QCOM is down just over 11% at $53.56. I anticipated that the results were going to be weak based on ASP and market share trends, but I didn't anticipate that the cost structure to worsen in conjunction with flattening revenue.
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Source: Amigobulls
I anticipate the stock will drop even further given weakening fundamentals and long-term uncertainty. The company was unwilling to provide full-year guidance, so visibility on earnings is more limited. Furthermore, it's not yet clear whether Qualcomm can maintain its current position in the high-end of the smartphone market as it may lose LTE modem share to Intel (NASDAQ:INTC). The company hasn't developed a large enough of a product portfolio outside of app processors and modem front/back-end silicon to offset weakness in core product fundamentals.
When compared to Qualcomm both Intel and Nvidia (NASDAQ:NVDA) are better plays. Both are better positioned to grow, as the number of enthusiast PC users are increasing, which improves ASP mix and volume at high-end SKUs. The PC market is expected to bottom out in CY'15 Q4, and ongoing growth in product adjacencies have offset weakness in core business units. Nvidia is at the cusp of another major refresh as they converge on Pascal architecture. Intel will be busy maximizing foundry margins on higher utilization/better yields on 3rd 14nm generation Kaby Lake. The better cost/product dynamics and ongoing ramp up in enterprise-specific silicon has helped boost Nvidia/Intel's revenue/earnings in the past year. Furthermore, these trends have meaningful legs going into FY 2016.
Therefore, investors should sell Qualcomm and consider buying Intel or Nvidia.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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