Qualcomm (QCOM) will report on Wednesday after the market closes. In January, I was cautious on the stock. I was worried about headline risk.
Last November, the China National Development and Reform Commission (NDRC) commenced an investigation into Qualcomm's business practices in China. The commission reviews how licenses and royalties are calculated, and also the value of cross-border intellectual property (IP) deals.
Qualcomm was accused of refusing to grant patent licenses to certain chip manufacturers. If Qualcomm is found guilty, the company would face a fine of between 1% and 10% of last year's revenue. The unknown nature of the fine, and how business will be conducted in the future, is weighing on the stock. In my opinion, any settlement will cause the stock to surge higher.
While the company has enough money to pay any fine, investors are worried about slowing growth. In fiscal 2013, revenue grew 30% to $24.8 billion. However, revenue is projected to increase only 7% in 2014 and 11% in 2015. Worse, gross margins peaked at 68% in 2011. Margins are expected to decline to between 61% and 62% this year and the next.
More specifically, for the fourth quarter, analysts are looking for $7.017 billion in revenue and $1.31 in earnings. Gross margin is expected to be weighed down due to seasonal factors, and could be as low as 56.5%. For the year, revenue should top $26.8 billion, and the company should earn $5.31.
Next year is more problematic: the consensus revenue estimate for 2015 stands at $28.9 billion or $5.58 per share, which works out to 7.89% and 5%, respectively. As the market for mobile phones gets saturated, Qualcomm's growth is slowing.
To grow, Qualcomm has been on a buying spree. Last month, Qualcomm paid $2.5 billion to acquire CSR, a leading developer of Bluetooth technology. Management said the next big opportunity in the semiconductor business was going to be the "Internet of Things," and being a major player in Bluetooth could help Qualcomm to grow faster.
Qualcomm also acquired Wilocity, an Israeli developer of wireless chipsets known as WiGig. WiGig operates on a higher frequency than Wi-Fi, which allows high-speed data transfer. The combined technologies could make Qualcomm a formidable player in the Internet of Things business, since devices such as health monitors will have to be wireless and able to transmit large volumes of data.
A lot of people continue to be bullish on Qualcomm, simply because the company dominates the mobile business. Most analysts have an $85 price target, which is made up of low double-digit earnings growth, dividends, and stock buybacks. I've even seen some $100 price targets. Those targets seem to be dependent on the company settling the royalty disagreement with China, and a huge upcoming mobile phone replacement cycle.
I'm staying cautious on Qualcomm. Two weeks ago, ARM Holdings (ARMH) reported a slow quarter, and investors pounded the shares. ARM grew third-quarter revenue by 12% to $320 million. ARM won't see revenue growth until the first quarter of next year, when the sales of the new iPhones hits its books. I don't want to be around for a beating, if Qualcomm disappoints investors like ARM did.
Until the China situation is cleaned up, and there are clear signs the company can re-accelerate its top line growth (and gross margins), I'm standing on the sidelines.