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Qualcomm Loses Its Sparkle as Supply Constraints Present a Double-Edged Sword

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Qualcomm's weak third-quarter guidance is weighing on the stock.

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Heading into yesterday's second-quarter earnings report, I considered Qualcomm (QCOM) to be the best semiconductor stock on planet Earth.

However, the company's weak third-quarter guidance has this momentum favorite hitting the skids following a steady 22% grind higher year-to-date.

So what's going on here?

Well, Qualcomm's second-quarter numbers were undeniably strong. The company reported a profit of $1.01 per share, beating consensus expectations by a nickel. Revenues came in at $4.94 billion, comfortably ahead of Wall Street's outlook.

However, in a major reversal from last quarter, Qualcomm didn't put up the big next-quarter guidance the bulls were seeking.

For the third quarter (ending in June), Qualcomm expects to earn $0.83 to $0.89 per share, the midpoint of which is below the $0.89 Wall Street consensus. Likewise, the company's revenue outlook of $4.45 to $4.85 billion does not compare well with the $19.4 billion consensus.

These aren't disastrous numbers -- but they're just not quite strong enough for a company facing high investor expectations.

Qualcomm is facing what is normally an extraordinarily high-quality problem: It is supply-constrained in its 28-nanometer 4G/LTE products. It just can't meet customer demand.

In isolation, this is a bullish development because it means the company is selling everything it can make.

However, Qualcomm did admit on the conference call that in some cases, customers were turning to solutions from Qualcomm competitors.

In terms of actual dollars and cents, this might not be a big problem. However, it is a reminder that for all of its strengths in terms of intellectual property, Qualcomm's chips do have some commodity flavor to them, since depending on the particular application, a customer can turn to a rival like NVIDIA (NVDA), Marvell (MRVL), Texas Instruments (TXN), Broadcom (BRCM), or Samsung (SSNLF) for a competing solution.

Strong earnings and guidance have a knack for sweeping investor concerns under the rug. But when weakness hits, folks start looking for warts where they never did before.

Frankly, if Qualcomm hadn't mentioned this issue, I think the stock would actually be up today.

Way back in January, after performing some basic algebra on Strategy Analytics' industry numbers, we determined that Apple (AAPL) and Samsung accounted for 86% of smartphone industry growth in the fourth quarter of 2011 -- a statistic that has been largely ignored by the mass media despite the fact that I trot it out every change I get. Does no one listen to me? (See: Samsung and Apple Now Account for 86% of Smartphone Industry Growth.)

Anyway, check out my favorite chart: When we back out Samsung and Apple, the smartphone industry grew by just 10% in Q4.



And given Nokia's (NOK) blowup this morning, and Research In Motion's (RIMM) back on March 29, that number could easily be north of 90% for the first quarter of 2012. Even the former Android highfliers HTC and Motorola (MMI) have seen their sales go straight down the toilet, and of course, we can't forget that Samsung is not just a smartphone/tablet maker; it is also a major mobile-semiconductor maker and often uses its own chips.

So to play devil's advocate in the face of widespread defense of Qualcomm this morning, I'll say this: While 3G/4G adoption is quite strong right now, there is no rising industry tide because not everyone can sell significant units into Apple and Samsung. And if Qualcomm is in fact shedding some business because of insufficient supply, there's no guarantee that the business comes back when the supply actually is there.

I don't think Qualcomm is on the brink of disaster -- but it doesn't appear to be on the edge of glory, either.

Going into the quarter, I was getting a very strong feeling that I was set to miss a very strong move to the upside, and I consider it sheer luck more than anything that I didn't hit the buy button.

However, I don't consider the decline a buying opportunity because I think increasing investor worries over competition offset the favorable supply-demand dynamics.

Thus, we have a wash, leaving this guy on the oh-so-safe sidelines with Qualcomm.

Furthermore, I think increasing investor uncertainty sets the stock up for an enormous move on the next earnings report, and I just don't have the confidence to pick a side yet.

Twitter: @MichaelComeau

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