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It May Be Time to Leave Qualcomm Behind

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Market competition and shifting customers make the company's efforts mute.

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What's wrong with Qualcomm (QCOM)?

The quick answer to that question is nothing, but that's not going to stop the stock from trading down 5% to 10% today. Investors were initially quite pleased with the $0.62 of pro forma EPS last night versus the street consensus of $0.56. However, an estimated $0.04 to $0.05 came from better-than-expected other income and a lower tax rate. That's not how you want your upside generated.

The real concerns came from weak guidance as well as some internal metrics that are heading in the wrong direction. Essentially, Qualcomm is seeing its customers shift to more low-end phones and it's seeing a lot more price pressure from competitors.

First let's take a look at its semiconductor operations, commonly referenced as QCT. A quick look at the graph below shows that Qualcomm's OEMs (Samsung, LG, etc.) are seeing their average prices for parts declining fairly steadily throughout 2009. In the December quarter just reported, the ASP was $17.48, down 17% from the prior year. There's no real erosion in margins because the company is able to lower its cost with the use of leading-edge process technologies. However, the lower pricing isn't producing much elasticity on the unit side. After recovering from the industry downturn, units have been fairly flat the last three quarters.



There's a very similar story taking place in Qualcomm's royalty business, referenced as QTL. The company recognizes royalties one quarter in arrears so the QTL revenue in last night's report is actually from units sold by OEMs in the September quarter. However, as you can see below, there's the same troubling pattern. Over the last two years, units are up 19% but the average price is down 17%. During the past year the unit gains are only 6% versus a price drop of 13%.



Some of this deterioration is mix related with the shift to lower-end handsets. However, some is clearly the deterioration of the older CDMA markets that aren't showing growth but generated some very profitable revenue streams in the past.

This isn't a problem that's unique to Qualcomm, but thus far it doesn't have available to it the solution that, let's say, Intel (INTC) does. As Intel drops its prices on older parts it's continually introducing new parts at the high-end to address the performance-hungry server/workstation market. Unfortunately, there's no equivalent market segment in the handset arena.

Qualcomm is trying to expand its market with its Snapdragon processor designed as a general-purpose mobile CPU targeting smartphones and netbooks. However, there's plenty of competition in that space (including Intel) so there will be no easing of the competitive pressure.

The company believes that it will see improving royalty ASPs later in 2010 calendar. I'm not certain how it expects that to happen but either way, Qualcomm isn't an inexpensive stock by any metric. With its future growth now under a cloud of suspicion, investors might want to play elsewhere.
No positions in stocks mentioned.
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