Company Description

Qualcomm is a semiconductor company which produces wireless communication chips for mobile devices. It belongs to the information technology sector and the telecommunications equipment subsector of S&P 500. The company has two major segments; one active in designing and developing of new devices and the other licensing of the developed products. Thus, more than 77% of the firm’s revenue is from loyalties of the licensed patents. Unlike many other semiconductor companies, such as Intel, Qualcomm does not have production facilities, so called fabs, and therefore is dependent on the third parties for manufacturing of its developed devices.

Investment Thesis

Based upon my macroeconomic analysis, IT sector has a promising short term and mid-term performance in the stock market. Qualcomm has had a healthy revenue growth of 30% to 40% which is anticipated to be 5-10% in the next two years. The company has consistently maintained its dominance in the market. My evaluation reveals a total return of above 9% by owning the stock. Qualcomm’s stock is also undervalued compared with the sector and S&P 500 index. Therefore, I recommend BUY for this stock.

Recommendation Risks

Although my recommendation is BUY for this stock, I also foresee risks associated with the company’s future earnings and therefore its stock performance. Legal challenges remain a major source of concern for the company. In January 2015, the firm paid close to $1Bn fine to the Chinese government for business irregularities. There are, however, other legal suits in China, South Korea and Europe that the company may face in near future. In addition, since the firm has no production facility, it is mainly dependent on the revenues generated by its R&D activities. A significant portion of the revenue is sourced to 2-3 customers. Any changes in the competitive landscape affecting the customers will significantly hamper revenue generation for the firm.

Recommendation: Buy

Qualcomm Inc.

Date: 4 April 2015

Current Price: $67.97

Target Price: $72.37

Total Return: 9.29%

Ticker: QCOM

Market Cap.: $112.12Bn

Dividend Yield: 2.82%

Shares Outstanding: 1.65Bn

52-Week Price Range: $81.60- $62.46

Trailing P/E= 14.36

Forward P/E= 12.52

P/Book= 2.96

P/Sales= 4.25

ONE YEAR PRICE

Analyst: Mehdi Mirsaneh, Mirsaneh.1@osu.edu 4 April 2015

Table of Contents

COMPANY OVERVIEW ....................................................................................................................... 3

Business Segments ........................................................................................................................ 3

Competitive Landscape and Current Challenges .......................................................................... 4

Qualcomm’s Sustained Competitive Advantage .......................................................................... 5

Recent Important News and Events ............................................................................................. 5

INVESTMENT THESES ....................................................................................................................... 6

Economic Analysis ........................................................................................................................ 6

Key Industrial Drivers ................................................................................................................... 7

Financial Analysis and DCF Model ............................................................................................... 8

Valuation Analysis ....................................................................................................................... 11

RISKS ................................................................................................................................................. 14

SUMMARY AND CONCLUDING REMARKS ................................................................................... 15

BIBLIOGRAPHY ................................................................................................................................ 16

APPENDIX 1: INCOME STATEMENT FORECAST- PART 1 ............................................................ 17

APPENDIX 2: INCOME STATEMENT FORECAST-PART 2 ............................................................ 18

APPENDIX 3: DCF MODEL .............................................................................................................. 19

APPENDIX 4: SENSITIVITY ANALYSIS OF VALUATION ............................................................. 20

Mehdi Mirsaneh

COMPANY OVERVIEW

Qualcomm is a semiconductor firm active in

the design and development of chip-based

devices for wireless applications. Formed in

1985 by seven industry veterans, Qualcomm

Communications landed its first contract in the

same year with the US army to work on secure

communications. In 1988, Qualcomm

launched a satellite tracking system to track

truck fleets for transportation industry. In the

following years, Qualcomm established itself in

the wireless communication systems by

developing new multi-transmitter systems

which use a single channel for wireless

communications, creating a path for the

application of GPS technology for commercial

use. In 1991, Qualcomm became a public

company by conducting its IPO on NASDAQ.

During the past 24 years, Qualcomm’s main

business activity had been in the research and

development of variety chipset designs, chiefly

for wireless communications. Its designs have

been employed by the main wireless

communication device manufacturers,

including Samsung and Apple to incorporate

variety of communication technologies,

including GPS, Voice, WiFi, Bluetooth etc., in

smart phones. In simple terms, Qualcomm’s

designs are applied using semiconductor

manufacturing processes in fabrication plants

(also called fabs or foundries). However,

Qualcomm is a fabless firm; that is, it has no

fabrication plants. Thus, the main activity of

Qualcomm is the research and development of

new designs, followed by licensing them to

third parties that own fabrication plants. This

business model has some advantages and

disadvantages which will be addressed in the

following sections.

Business Segments

Qualcomm business is mainly composed of two

major units:

1- Qualcomm CDMA Technologies (QCT),

which owns the R&D, products and services

including the semiconductor services, and

covers all product development activities.

2- Qualcomm Licensing business (QTL), which

owns the majority of the company’s patent

portfolio, and covers all licensing activities of

the company.

QCT is the backbone of the business. In fact,

the income from QTL does not materialize

without the products developed at the QCT

business. QTL licenses the technologies which

are developed by the QCT. QCT also directly

involves in production and sales in cooperation

with partners (as explained in the previous

section) and has a larger value of sales

compared with QTL, see below graphs.

However, the largest earning is attributed to

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the QTL, since the segment’s activities are only

licensing which incur almost no costs.

Competitive Landscape and Current Challenges

The huge increase in the usage of mobile

devices including cell phones and tablets has

been the main driver of growth for

semiconductor industry. As shown in the below

graphs, in 2012, mobile devices accounted for

62% of the total semiconductor market. While

the total market for semiconductor industry is

expected to grow to $380Bn, wireless

communication applications are anticipated to

have the largest growth (~11%), accounting for

32% of the market (~$120Bn) [1].

However, there are challenges facing the firms

within the industry including Qualcomm. The

foundries, or fabs, are extremely expensive

(around $4Bn) to build and have high fixed

costs. Therefore, only firms with a huge market

can set up and run the facilities. Alternatively,

there are firms which only manufacture

(mainly located in Taiwan and China) devices,

licensing designs from fabless firms such as

Qualcomm. Intel, the giant semiconductor

manufacturer, and Samsung are the rare firms

which are vertically integrated into design and

have foundries. The consolidation of

Sales

Earnings

Comp Annual Growth Rate

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manufacturing within few fab-based firms and

the mobile device customers in mainly two

firms (Apple and Samsung) have created

limited maneuver space for fabless firms.

Therefore, companies such as Qualcomm are

facing the challenge of competition to sell

designs to Apple and Samsung and at the same

time encountering little bargaining power over

foundries, reducing their profit margin

significantly. Moreover, R&D activities are

generally associated with high initial costs. The

risk for a firm like Qualcomm, therefore, is that

the developed designs fail to grasp the

attention of the big players/customers (Apple

and Samsung) in the field, resulting in a huge

sunk cost for the company. Moreover, the

company is facing antitrust government

investigation which could cost the enterprise

billions of dollars. This challenge will be

addressed in more detail in the “Recent

Important News and Events” section.

Qualcomm’s Sustained Competitive Advantage [2]

As previously mentioned, there are challenges

facing a fabless firm like Qualcomm, but it is

vital to note that Qualcomm has some

competitive advantages which seem to sustain

for foreseeable future. Qualcomm’s main

advantage is its vast portfolio of intellectual

property which covers the multi-channel

communications (transmitting variety of data

including voice, video and text over the same

band, also described as 3G/4G technologies).

Qualcomm currently collects $7 loyalty fee

from each smart phone sold globally and this

will soon grow dramatically. Presently, only

20% of all cell phones sold globally are smart

phones (work on 3G/$G technologies). This

figure is expected to grow fast within the next

few years, creating almost one way profit

generating path for Qualcomm. In addition,

Qualcomm intelligently has used this

advantage to form a monopoly in the market as

its all other designs are integrated into the

original platform which is covered by its

intellectual property, making the customers

dependent on Qualcomm wireless devices.

Therefore, it appears that a mixture of

intellectual property and design integration

along with huge investment in R&D are

Qualcomm’s competitive advantages which are

anticipated to be sustainable for years to come.

Recent Important News and Events

The most important news has been settling the

Chines antitrust government investigation in

the early days of January 2015. Qualcomm was

under investigation for the market monopoly

in China as a result of competitors’ protest.

Following few months of investigation,

Qualcomm eventually settled the dispute by

paying close to $1Bn fine to the Chinese

government. Although this was positive news,

it appeared that the antitrust woes are far from

over, as the South Korean government also

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announced that it was looking in a similar

pattern of activities in Korea. This was in

addition to other news that the US and

European governments had also initiated

similar investigations [3]. Although, none of

the other investigations have shown any sign of

misconduct, the presence of such negative

news around the firm affects the performance

of Qualcomm stocks in the market.

INVESTMENT THESES

Economic Analysis

The technology sector has a cyclical pattern

which closely follows the overall economic

trend of the country. Since many companies in

the IT sector manufacture consumer products,

it is possible to predict the earning trend in the

sector by evaluating the consumer spending

pattern. Figure below [4] reveals the personal

savings and household net worth

simultaneously, revealing that the personal

savings increases (or spending decreases) when

the household net worth increases. There are

many factors affecting household net worth,

including employment, household expectation

of future income growth, housing prices etc.

Looking at the net worth trend and the

aforementioned parameters which are affecting

it, I anticipate that the consumer spending

increases within the next 12 to 18 months. As

the sector’s earning grows, the stock will have a

positive performance, as expected. Thus, I

expect that the IT sector will have a promising

near term stock performance.

Following the 2008 financial crisis, we

observed government interference to limit the

crisis using different strategies including

decreasing the interest rate to almost zero%.

However, it is expected that the Fed will soon

increase interest rates. Table below [5] shows

the expected effect of interest rise on different

sectors, indicating that the technology sector is

predicted to have the highest positive

performance as a result of the interest rate rise.

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Since Qualcomm is a member of the

Communications Equipment subsector of the

IT sector, it is also important to assess the

performance of this subsector against the IT

sector and the S&P 500, below figure. It is

evident that the subsector’s performance has

been consistently underperformed the sector,

indicating that the performance gap between

the sector and subsector may increase in near

future (sign of further underperformance).

Key Industrial Drivers

Smart Phone Usage

As explained above, one of the major

applications of Qualcomm’s products is in

multi-channel communication of voice and

data simultaneously, in particular in portable

devices such as smart phones, Tablets etc.

Thus, it is apparent that the usage of smart

portable devices and their production and sales

would be the main driver for the Qualcomm’s

revenues. Below graphs show various smart

device usage forecast till 2016 for different

applications and regions, indicating a

significant growth, especially in smart phones

and in Asia-Pacific [6]. Therefore, it is

anticipated a steady market growth for

Qualcomm’s CDMA based platform products

which support data –voice -video

communications used in the aforementioned

devices.

3G/4G

Third and fourth generation (3G & 4G) cell

phones have been a key driver of the growth in

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the usage of smart phones. As of 2014, there

have been 2.8Bn devices based on these

technologies which are expected to grow to 5Bn

by 2018. Presently, the CDMA design is the

superior product in the market and has the

largest market share. Therefore, providing

CDMA remains the best choice in the market,

Qualcomm’s revenue is expected to grow.

Internet of Things

The Internet of Things is a concept in which

different smart devices are connected with

each other through internet, creating a new

market for wireless connecting devices.

Qualcomm’s designs and products have put the

firm in a strategic position to take advantage of

this huge market which is expected to reach

~$41Bn by 2020 [7], see below graph. It

appears that Qualcomm has already taken the

steps to dominate this market by developing

new wireless communication devices for

healthcare and auto industry [8].

Other Players

Another key driver for Qualcomm’s revenue is

the fact that whether its products remain the

customers’ choice of design in future. Recently,

Intel has started to develop similar products

which could significantly challenge

Qualcomm’s sales in future. Samsung, itself a

device designer, may introduce new products

which can outclass Qualcomm designs, leading

to the loss of product dominance by company.

Financial Analysis and DCF Model

Revenues

As shown in Appendix 1 also in below table, my

revenue projection is in line with the analysts’

consensus. Looking at the historical revenues

below graph, apart from 2011 to 2013 when

there was a large increase in the growth rate

(likely due to the after-recession effect), the

growth had been between 5-6%. Therefore, I

chose a 5.5% growth rate and decreased it to

4~% to highlight the fact that the growth will

most likely approaches to the nominal GDP

growth of 4% in coming years. While the

growth between 2011 and 2013 was 30% - 40%,

it is vital to note that it is unlikely that the firm

could realize such a large revenue growth

within the next few years.

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Revenue My Projection Analysts’ Consensus

2015 $27,948m $27,194m

2016 $29,503m $28,476m

As noted in the SEC fillings of the firm [9],

there are two main segments which are the

source of revenue generation; i.e. equipment-

services and licensing. Equipment and services

is the larger source and expected to growth at a

larger pace compared with the licensing

section. In 2014, equipment and services

revenues, which were mostly related to sales of

MSM and accompanying RF and PM

integrated circuits, were $18.43Bn, forming

almost 99% of QCT segment revenue. The QTL

section, however, generated only $7.6Bn in

2014 and was mainly flat. The firm attributed

the low growth rate in this segment to the

under-reported royalty fees from licensees, in

particular in China where the huge legal battle

has undermined the firm operation. Indeed,

the positive impact of the legal resolution in

China on the revenue growth of this segment

needs to be seen. The fact that the growth in

revenue in the QTL segment has been flat is

alarming, since this segment contributes a

much larger profit margin to the firm’s income.

According to the firm fillings [9], China, South

Korea and China comprised 50%, 23% and 11%

of revenue generations, respectively, majority

of which through loyalties of licensed designs.

Although, Chinese market growth seems

promising, Qualcomm’s legal challenges in the

country may hamper its future growth; see the

risk section.

Gross Profit

Below figure shows my projection of gross

profit against the analysts’ consensus,

highlighting that my gross profit projection for

2015 and 2016 was slightly higher than the

analysts’.

Gross Profit My Projection Analysts’ Consensus

2015 $17,607m $15,950m

2016 $19,177m $17,061m

Although the main reason behind this

difference will be revealed when the relevant

costs are discussed, I would like to mention

one key point here. As stated above my revenue

projection was closely following the analysts’,

Revenue

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and therefore, the main reason behind the

difference should be associated with the costs

projection. This could be, alternatively, seen in

the gross profit margin as shown in the below

table, revealing a higher estimation of profit

margins in my projection, in contrast to the

analysts’.

Gross Profit Margin My Projection Analysts’ Consensus

2015 63.0% 58.7%

2016 65.0% 59.9%

As discussed previously, QTL segment has

higher profit margin and one may logically

contribute the differences to the QTL’s

projection. However, since the QTL has a

negligible cost, as it is only a licensing unit, I

believe the main differentiating source is the

projection of the QCT’s revenue.

Cost of Equipment and Services

The majority of the cost of equipment and

services is associated with the QCT business

unit, as the QTL has no significant costs, as

described before, due to its business activity

which is merely licensing of designs. According

to the SEC filing of the firm in 2014 [9], the

cost of equipment and services also includes

the cost of shipping and handling. Due to the

economic downturn in the rest of world and

low energy costs as well as labor costs, I

anticipate that the cost of equipment and

services remain flat, in contrast with the

consensus projection of growth for these costs,

below table.

Cost of Eq. & Services

My Projection Analysts’ Consensus

2015 $10,341m $11,243m

2016 $10,326m $11,415m

Research and Development

Rapid technological changes in the wireless

communication industry demands huge

investment in the research and development

for firms which intend to remain competitive

within the sector. Looking at the financial

statement of the firm, Qualcomm has increased

its investment in R&D significantly, ~83%

increase from 2011, signaling that it has

prepared itself for the fierce competition in

future. Thus, I predict that this investment will

result in higher revenues in the next 3 to 5

years. Increased investment in R&D helps

Qualcomm maintain its leadership position in

its flagship designs in the LTE baseband

market which the firm currently holds ~95% of

market share [7].

Selling, General and Administrative (SG&A) Costs

As revealed in the income statement of the

company, SG&A is the third largest cost,

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forming ~12% of the total costs. According to

the firm’s SEC filing, SG&A includes legal costs

(~2.6%), share-based compensation (2.3%)

and marketing and employee compensation

costs. During 2014, firm has encountered

higher employee and marketing expenses,

leading to higher SG&A costs. The $56m

increase in marketing expenses seems to be in

line with the firm’s attempt to maintain its

market share, a positive move which should

translate into higher revenues in future.

Earnings Per Share (EPS)

Based on my evaluation, I expect that the

firm’s EPS to grow at 7-9% annually in the next

two years, reaching $5.31. This is consistent

with some analysts’ forecast which indicated an

EPS of $5.44 in 2016 [10], below table.

Earnings Per Share

My Projection Analysts’ Consensus

2015 $4.96 $5.02

2016 $5.31 $5.44

However, some other analysts had a slightly

different projection, in particular for 2015 [11].

They forecast EPS of $3.5 to $4.75 for 2015,

which is smaller than my and Bloomberg

analysts’ expectations. This could be due to a

different projection of revenues for the coming

year, attributed to difficulties and risks in

China. However, as explained previously, this

risk has been almost eliminated by the new

legal settlement agreement which occurred at

the end of January 2015. On March 9 2015,

Qualcomm announced that it will repurchase

$10Bn of its stock and increase dividend by

about 14% in the next 12 months [12].

Improving the EPS (by reducing the number of

shares outstanding) and increasing the

dividend will positively affect the firms stock

price in near future.

Valuation Analysis

Valuation Based on Multiples

So far the valuation analysis was based on the

DCF model which aims to look at the intrinsic

value of stocks compared to the current market

price. In this section, I will look at Qualcomm’s

current market price and compare it with the

index (S&P 500), the information technology

sector and the competitors to assess how the

firm’s stock performing in the market.

Although, this assessment provides us with

useful information, the DCF is indeed the best

way to identify undervaluation.

Qualcomm vs S&P 500

Below graph reveals the Qualcomm’s share

price in the past 12 months, compared with

S&P 500 index, showing that the firm’s stock

has performed negatively compared with the

market. The following table compares

Qualcomm’s P/E, P/B, P/S and P/EBITDA

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relative to S&P 500, in the past 12 months. The

current P/E ratio is 0.79, indicating that it is

relatively smaller than the S&P 500. During the

past 12 months, however, P/E ratio of

Qualcomm compared with S&P 500 was

ranging from 0.61 to 1.19 with a median of

0.90. Thus, the data reveals that the current

P/E ratio of Qualcomm is lower than the

median within the past year. The P/B ratio,

relative to S&P 500, is indeed the lowest within

the past 12 months. Similarly, P/S ratio

compared with S&P 500 is now the lowest

within the past 12 months.

Looking merely at these ratios and market

share price compared to S&P 500, it appears to

me that Qualcomm’s shares are currently

undervalued. However, it is key to note that the

more important comparison is between

Qualcomm and the sector and peers, the

upcoming sections, which will reveal more

accurately how the stock has been performing.

QCOM vs S&P 500 High Low Median Current

P/E 1.19 0.61 0.90 0.79

P/B 1.77 1.04 1.21 1.04

P/S 5.41 3.21 3.28 3.21

Qualcomm vs Information Technology Sector

In comparison to the IT sector, Qualcomm’s

P/E ratio is lower than 1 and is lower than the

median during the past 12 months, see below

table. Similarly, the P/B ratio vs the sector is

now the lowest within the last year. In contrast,

P/S seems to be relatively always higher than

one, although this ratio was the lowest

compared to the sector within the last 12

months. Therefore, in summary, it appears that

Qualcomm’s stock ratios vs the sector is either

at the lowest or close to lowest, indicating that

Qualcomm’s stock is undervalued.

QCOM vs IT Sector High Low Median Current

P/E 1.27 0.50 0.77 0.73

P/B 1.10 0.69 0.80 0.69

P/S 3.76 1.34 1.89 1.34

S&P 500

Qualcomm

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Qualcomm vs Peers

Relatively to its peers, Qualcomm’s ratios are

shown in the below table. The peers have been

chosen based on the products and the market

and how close is their business to Qualcomm.

These firms are either manufacturing

competing products or are semiconductor

firms that do not possess foundry (they are

fabless), similar to Qualcomm.

Apart from Micron Technology which has a

P/E ratio of 9.58, Qualcomm’s P/E ratio is

almost the lowest compared to peers. The P/B

ratio seems to be slightly different as

Qualcomm’s ratio is slightly higher than the

average of peers’ P/B ratios (3.00). The

average P/S ratio of peers is 3.55, which is

lower than Qualcomm’s. P/CF seems to follow

the same story line, as the average (15.17) is

lower than Qualcomm’s (15.95).

In summary, it seems to me that, apart from

the P/E ratio, Qualcomm’s other ratios are

higher than the peers, indicating that

Qualcomm’s stock price is overvalued in the

market relative to its peers.

Multiples Evaluation Price Target

Based on my assessment of Qualcomm’s

multiples versus the comparable firms, sector

and market, I identified my target multiples

each of which lead to different target prices. As

shown in the below table, the average of the

target prices is 14.9% higher than the current

market price for Qualcomm’s stock, indicating

that overall Qualcomm’s stock is presently

undervalued, a similar conclusion to DCF

valuation model.

Abs Valuation Current

My Target

Multiple

Target /Current

Exp. EPS Target

Price

P/E 15.73 20 1.27 $4.5 $90

P/B 3.09 3.5 1.13 N/A $81.6

P/S 4.6 4 0.87 N/A $62.8

P/EBITDA 13.83 15 1.09 N/A $78.7

Average $78.1

Upside/ Downside Potential Over Current Stock Price ($67.97) 14.90%

P/E P/B P/S P/CF

Qualcomm 15.73 3.09 4.60 15.95

Broadcom Corp. 31.0 2.98 2.9 17.40

Texas Instrument 20.6 4.54 5.6 17.11

Intel Corp. 15.58 3.06 3 16.37

Marvell Technology 17.41 2.11 ---- 12.70

NVIDIA Corp 19.55 2.45 2.7 16.37

Maxim Integrated 27.42 3.92 4.3 15.12

Micron Technology 9.58 1.98 2.8 11.14

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RISKS

Owning Qualcomm’s stocks similar to any

other stock is associated with risks. The risks

which are affecting the firm’s revenue would

affect its stock price too. It is therefore

important to evaluate the risks that

Qualcomm’s facing and how these risks could

impact its revenues in the coming years.

Narrow Range of Products

Qualcomm has limited number of very

successful products including CDMA and

OFDMA. The company’s revenue is therefore

dependent on the fact that these designs are

deployed by the customers and that the

customers develop other devices based on

these designs. The CDMA design accounts for

around 45% of Qualcomm’s revenue [13].

However, the firm has consistently lost the

market share to the competitors in the past ten

years. The market share which was once

around 81% reduced to ~60% in 2010 and

reduced further in the following years.

A main risk for Qualcomm is that the wireless

carriers and/or customers use other competing

technologies in future, instead. This will most

likely completely wipe out a major source of

revenue for the firm with disastrous

consequences.

Moreover, the future cash flow projection of

Qualcomm depends on the future adaptation of

3G/4G technologies in the developing markets.

Any delay in this trend could also significantly

affect Qualcomm’s future cash flows. The

expansion in the 3G/4G networks is dependent

on governments’ regulations. However, it is

known that governments’ actions are generally

associated with unpredictable delays, making

future employment of Qualcomm’s

technologies even less certain.

Limited Number of Customers

Qualcomm’s customers are mainly major

portable wireless device manufacturers

including Samsung and Apple. Samsung alone

accounts for ~20% of Qualcomm’s revenue.

However, Samsung itself is a designer and

manufacturer of wireless devices which may, at

any point, decide to develop its own products,

instead of paying royalties to Qualcomm.

Recently, January 2015, Samsung announced

that it may not deploy Qualcomm’s

Snapdragon 810 product in its Galaxy S6 smart

phones due to some technical issues.

During the company’s quarterly earnings

report on 28 Jan 2015, Qualcomm’s CEO, Steve

Mallengkopf, stated that “we now expect that

our Snapdragon 810 processor will not be in

the upcoming design cycle of a large customer’s

flagship device, impacting our outlook for both

volume and content in that device”. Qualcomm

owns around 94% of market share in LTE

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devices via its flagship product series of

Snapdragon.

Moreover, Intel, another Qualcomm’s major

customer and competitor may develop devices

and designs which outclass the firm’s products,

making them instantly obsolete. In fact, it was

announced that Intel would partially replace its

design in Apple’s IPhone products in 2016 [14].

The release of this single information on 11

March 2015 by an unknown source resulted in

2.25% drop in Qualcomm’s market share price,

while Intel gained around 2%.

Legal Challenges

Recently Qualcomm was engaged in a legal

battle in China due to an investigation by the

Chinese government’s antitrust agencies which

found illegal activities by Qualcomm. China is

almost the largest market for the firm. Even

the announcement of the investigation affected

Qualcomm’s earning as some of the firm’s

clients stopped paying their royalties for the

licensed designs. Thus, a negative legal

outcome could affect the firm’s future cash

flows significantly. However, the good news

was that Qualcomm could settle the dispute in

January 2015 by paying ~1Bn fine to the

Chinese government as well as agreeing a

change in its business model in the country.

However, it appears that the legal issues in

China are far from over. In March 2015, a

Chinese firm sued Qualcomm for trademark

infringes, asking for $100Bn of compensation.

Following the antitrust settlement in China,

South Korean and EU authorities also

announced that they had initiated an

investigation into Qualcomm’s activities in

their countries. If it is found guilty by the EU,

Qualcomm may be fined up to 10% of its global

revenues.

SUMMARY AND CONCLUDING REMARKS

Based on my analysis which is reviewed in this

document, I believe that the IT sector will have

an above average performance in the stock

market in near future. In particular, the return

of the sector will be higher if there is interest

rate rise by the Fed. However, the

Communications Equipment sub-sector might

have a weaker performance than the average of

the sector. My assessment reveals that

Qualcomm’s stock is slightly undervalued,

according to the DCF model (6.48%) and

multiples valuation (14.9%). There are,

however, risks associated with stock

recommendation. The firm’s future revenue

growth is highly dependent on many factors

which are not under the control of the

company. These include but not limited to the

narrow customer base, legal and antitrust

issues in Asia and Europe, low profit margin

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and the competitive nature of the industry.

However I believe the return outweighs the

risks, and therefore, I recommend BUY for

Qualcomm’s stock.

BIBLIOGRAPHY

[1] McKinsey&Company, "McKinsey on Semiconductors," McKinsey Practice Publications, 2013.

[2] V. Katsenelson, "Qualcomm's Competitive Advantage Are Too Numerous to Ignore," Institutional Investor, 25 11 2013. [Online]. Available: http://www.institutionalinvestor.com/blogarticle/3282549/blog/qualcomms-competitive-advantages-are-too-numerous-to-ignore.html#.VSLAJ_nF-h1. [Accessed 2015 04 04].

[3] C. Neiger, "Qualcomm's Antitrust Woes Are Far From Over," 19 02 2015. [Online]. Available: http://www.fool.com/investing/general/2015/02/19/qualcomms-antitrust-woes-are-far-from-over-but-inv.aspx. [Accessed 04 04 2015].

[4] D. Roberts, Economic Outlook, 2015. [5] N. Bohnsack, Quantitative Research &

Global Asset Allocation, 2015. [6] "The Blog," 04 06 2012. [Online].

Available: http://zeendo.com/info/mobile-growth-forecast/. [Accessed 04 04 2015].

[7] P. Sikka, "Market Realist," 19 11 2014. [Online]. Available: http://marketrealist.com/2014/11/qualcomm-plans-tap-internet-things-market-growth/. [Accessed 04 04 2015].

[8] Compnay Website, "Qualcomm," [Online]. Available: https://www.qualcomm.com/. [Accessed 04 04 2015].

[9] SEC 2014 Filings, "SEC," 2014. [Online]. Available: http://www.sec.gov/Archives/edgar/data/804328/000123445214000320/qcom10-k2014.htm. [Accessed 04 04 2015].

[10] Bloomberg, [Online]. [Accessed 2015]. [11] 4-traders, "Qualcomm," [Online].

Available: http://www.4-traders.com/QUALCOMM-INC-4897/?type_recherche=rapide&mots=qcom. [Accessed 04 04 2015].

[12] L. Gensler, "Qualcomm Plans $15B Stock Buyback, Hikes Dividend," Forbes, 09 03 2015. [Online]. Available: http://www.forbes.com/sites/laurengensler/2015/03/09/qualcomm-plans-15b-stock-buyback-hikes-dividend/. [Accessed 04 04 2015].

[13] Forbes Magazine, "Qualcomm Cruises To $53 If It Slows Bleeding In CDMA Market Share," Forbes, 20 10 2010. [Online]. Available: http://www.forbes.com/sites/greatspeculations/2010/10/20/qualcomm-cruises-to-53-if-it-slows-bleeding-in-cdma-market-share/. [Accessed 04 04 2015].

[14] M. Perrault, "Intel, Not Qualcomm, Modem Chips For iPhones: Report," Investor.com, 11 03 2015. [Online]. Available: http://news.investors.com/technology/031115-743065-intel-modem-chips-reportedly-might-go-into-iphones.htm. [Accessed 04 04 2015].

Stock: Qualcomm Inc.

Ticker: QCOM

Current Price: $67.97

Target Price: $72.37

Recommendation: buy

Analyst: Mehdi Mirsaneh

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APPENDIX 1: INCOME STATEMENT FORECAST- PART 1

Consensus- Revenue 29,909$ 28,470$ 27,100$ 2017E 2016E 2015E 2014 2013 2012 2011 2010

Revenues:Equipment and Services 22,390$ 21,324$ 19,929$ 18,625$ 16,988$ 12,465$ 9,223$ 6,971$ Licensing 8,261$ 8,180$ 8,019$ 7,862$ 7,878$ 6,656$ 5,734$ 4,011$

Total Revenue 30,651$ 29,503$ 27,948$ 26,487$ 24,866$ 19,121$ 14,957$ 10,982$ Costs and expenses:

Cost of equimpent and services revenues 10,728$ 10,326$ 10,341$ 10,686$ 9,820$ 7,096$ 4,877$ 3,301$ Research and development 6,130$ 5,901$ 5,590$ 5,477$ 4,967$ 3,915$ 2,995$ 2,451$ Selling, general and adminstrative 2,759$ 2,655$ 2,515$ 2,290$ 2,518$ 2,270$ 1,945$ 1,503$ Other 552$ 531$ 503$ 484$ 331$ 158$ 114$ -$

Total costs and expenses 20,169$ 19,413$ 18,949$ 18,937$ 17,636$ 13,439$ 9,931$ 7,255$ Operating income 10,483$ 10,090$ 8,999$ 7,550$ 7,230$ 5,682$ 5,026$ 3,727$ Investment income, net 1,379$ 1,328$ 1,258$ 1,228$ 964$ 880$ 661$ 766$

Income from continuing operations before income tax 11,862$ 11,418$ 10,257$ 8,778$ 8,194$ 6,562$ 5,687$ 4,493$ Income tax expense (1,779)$ (2,055)$ (1,539)$ (1,244)$ (1,349)$ (1,279)$ (1,132)$ (973)$

Income from continuing operations 10,083$ 9,363$ 8,718$ 7,534$ 6,845$ 5,283$ 4,555$ 3,520$ Discontinued operations, net of income taxes -$ -$ -$ 430$ -$ 776$ (313)$ (273)$

Net income 10,083$ 9,363$ 8,718$ 7,964$ 6,845$ 6,059$ 4,242$ 3,247$ Net loss attributable to noncontrolling interests -$ -$ -$ 3$ 8$ 50$ 18$ -$

Net income attributable to Qualcomm 10,083$ 9,363$ 8,718$ 7,967$ 6,853$ 6,109$ 4,260$ 3,247$

Basic earning per share attributable to Qualcomm:Continuing operations 4.48$ 3.99$ 3.14$ 2.76$ 2.15$ Discontinoued operations 0.25$ -$ 0.45$ (0.19)$ (0.17)$ Net income 4.73$ 3.99$ 3.59$ 2.57$ 1.98$

Diluted earnings per share attributable to Qualcomm:Continuing operations 4.40$ 3.91$ 3.06$ 2.70$ 2.12$ Discontinoued operations 0.25$ -$ 0.45$ (0.18)$ (0.16)$ Net income per share (EPS) 5.88$ 5.46$ 5.09$ 4.65$ 3.91$ 3.51$ 2.52$ 1.96$ Consensus EPS 5.68$ 5.31$ 4.96$

Shares used in per share calculations:Basic 1,683 1,715 1,700 1,658 1,643 Diluted 1,714 1,714 1,714 1,714 1,754 1,741 1,691 1,658

Dividend per share announced 1.54$ 1.20$ 0.93$ 0.81$ 0.72$

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APPENDIX 2: INCOME STATEMENT FORECAST-PART 2

Inventories 1,686$ 1,623$ 1,537$ 1,458$ 1,302$ 1,030$ 765$ 528$ % of sales 5.50% 5.50% 5.50% 5.50% 5.24% 5.39% 5.11% 4.81%

Accounts receivable, net 2,759$ 2,655$ 2,515$ 2,412$ 2,142$ 1,459$ 993$ 730$ % of sales 9% 9% 9% 9.11% 8.61% 7.63% 6.64% 6.65%

Trade accounts payable 2,452$ 2,360$ 2,236$ 2,183$ 1,554$ 1,298$ 969$ 764$ % of sales 8% 8% 8% 8.24% 6.25% 6.79% 6.48% 6.96%

Change in WC (75)$ (101)$ (130)$ 203$ (699)$ (402)$ (295)$ (494)$ Revenue Change

Equipment and services as % of sales 70.32% 68.32% 65.19% 61.66% 63.48%Annual growth rate 5.0% 7.0% 7.0% 9.64% 36.29% 35.15% 32.31% 8.30%

Licensing as % of sales 29.68% 31.68% 34.81% 38.34% 36.52%Annual growth rate 1.0% 2.0% 2.0% -0.20% 18.36% 16.08% 42.96% 1.54%

Total Revenue % change 3.89% 5.57% 5.52% 6.52% 30.05% 27.84% 36.20% 5.73%Costs & expenses

Cost of equimpent and services revenues as % of sales 35% 35% 37% 40.34% 39.49% 37.11% 32.61% 30.06%Annual % change 8.82% 38.39% 45.50% 47.74% 9.12%

Research and development as % of sales 20.0% 20.0% 20.0% 20.68% 19.98% 20.47% 20.02% 22.32%Annual % change 10.27% 26.87% 30.72% 22.20% 4.52%

Selling, general and adminstrative as % of sales 9.0% 9.0% 9.0% 8.65% 10.13% 11.87% 13.00% 13.69%Annual % change -9.05% 10.93% 16.71% 29.41% 2.80%

Other as % of sales 1.80% 1.80% 1.80% 1.83% 1.33% 0.83% 0.76% 0.00%Annual % change 46.22% 109.49% 38.60% #DIV/0! -100.00%

Total cost % change 3.89% 2.45% 0.06% 7.38% 31.23% 35.32% 36.88% -7.52%Inestment income as % of sales 4.50% 4.50% 4.50% 4.64% 3.88% 4.60% 4.42% 6.98%Annual growht rate 27.39% 9.55% 33.13% -13.71% #DIV/0!

Operating margin 38.70% 38.70% 36.70% 33.14% 32.95% 34.32% 38.02% 40.91%Effective tax rate 15% 18% 15% 14.2% 16.5% 19.5% 19.9% 21.7%

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APPENDIX 3: DCF MODEL

Discount factor 10.75%Long term growth rate 4.0%Year 2014 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023 2014 2025

Revenue 26,487$ 27,948$ 29,503$ 30,651$ 32,184$ 33,632$ 34,978$ 36,377$ 37,832$ 39,345$ 40,919$ 42,555$ %Grow th 5.5% 5.6% 3.9% 5.0% 4.5% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0%

Operating Income 8,778$ 10,257$ 11,418$ 11,862$ 11,586$ 11,771$ 11,892$ 12,368$ 12,863$ 13,377$ 13,912$ 14,469$ Operating Margin 33.1% 36.7% 38.7% 38.7% 36.0% 35.0% 34.0% 34.0% 34.0% 34.0% 34.0% 34.0%

Taxes (1,244)$ (1,539)$ (2,055)$ (1,779)$ (1,738)$ (1,766)$ (1,784)$ (1,855)$ (1,929)$ (2,007)$ (2,087)$ (2,170)$ Tax Rate 14.2% 15.0% 18.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0%

Net Income 7,967$ 8,718$ 9,363$ 10,083$ 9,848$ 10,006$ 10,108$ 10,513$ 10,933$ 11,371$ 11,826$ 12,299$ %Grow th 16.3% 9.4% 7.4% 7.7% -2.3% 1.6% 1.0% 4.0% 4.0% 4.0% 4.0% 4.0%

Depreciation & Amortization 1,150$ 1,258$ 1,328$ 1,379$ 1,448$ 1,513$ 1,574$ 1,637$ 1,702$ 1,771$ 1,841$ 1,915$ % of sales 4.3% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50%

Changes in WC 203$ (130)$ (101)$ (75)$ (97)$ (101)$ (105)$ (109)$ (113)$ (118)$ (123)$ (128)$ % of sales 0.77% 0.46% 0.34% 0.24% 0.30% 0.30% 0.30% 0.30% 0.30% 0.30% 0.30% 0.30%

CapEx 1,185$ 1,258$ 1,328$ 1,379$ 1,448$ 1,513$ 1,574$ 1,637$ 1,702$ 1,771$ 1,841$ 1,915$ CapEx % of sales 4.47% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50% 4.50%

Free Cash Flow 8,135$ 8,589$ 9,262$ 10,008$ 9,752$ 9,905$ 10,004$ 10,404$ 10,820$ 11,253$ 11,703$ 12,171$

NPV of Cash Flows 63,056 50.8%NPV of terminal value 60,992 49.2% Terminal Value 187,522 Projected Equity Value 124,047 100.0%Free Cash Flow Yield Free Cash Yield 6.49%

Current P/E Terminal P/E 15.2 Projected P/ECurrent EV/EBITDA Terminal EV/EBITDA 2.6 Projected EV/EBITDA

Shares Outstanding 1,714

Current Price 67.97$ Implied equity value/share 72.37$ Upside/(Downside) to DCF 6.48%

Debt - Cash 17,790 Cash/share 10.38

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APPENDIX 4: SENSITIVITY ANALYSIS OF VALUATION

Sensitivity Analysis:72.37$ 9.25% 9.75% 10.25% 10.75% 11.25% 11.75% 12.25% 12.75%

1% 72.42$ 68.07$ 64.19$ 60.71$ 57.58$ 54.75$ 52.18$ 49.83$

2% 77.32$ 72.20$ 67.69$ 63.71$ 60.16$ 56.98$ 54.12$ 51.52$

3% 83.79$ 77.55$ 72.17$ 67.48$ 63.37$ 59.72$ 56.47$ 53.56$

4% 92.73$ 84.77$ 78.07$ 72.37$ 67.46$ 63.17$ 59.40$ 56.07$

5% 105.87$ 95.02$ 86.23$ 78.96$ 72.85$ 67.64$ 63.14$ 59.22$

6% 127.09$ 110.74$ 98.23$ 88.33$ 80.30$ 73.66$ 68.08$ 63.31$ 7% 167.18$ 137.90$ 117.60$ 102.69$ 91.26$ 82.22$ 74.89$ 68.82$

Discount Rate

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Sensitivity Analysis:3.64% 9.25% 9.75% 10.25% 10.75% 11.25% 11.75% 12.25% 12.75%

1% 3.7% -2.5% -8.1% -13.1% -17.5% -21.6% -25.3% -28.6%2% 10.7% 3.4% -3.1% -8.8% -13.8% -18.4% -22.5% -26.2%3% 20.0% 11.1% 3.3% -3.4% -9.3% -14.5% -19.1% -23.3%4% 32.8% 21.4% 11.8% 3.6% -3.4% -9.5% -14.9% -19.7%5% 51.6% 36.1% 23.5% 13.1% 4.3% -3.1% -9.6% -15.2%6% 82.0% 58.6% 40.7% 26.5% 15.0% 5.5% -2.5% -9.3%7% 139.4% 97.5% 68.4% 47.1% 30.7% 17.7% 7.2% -1.4%

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