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Morningstar | Qualcomm To Receive Roughly $4.6 Billion in Catch-Up Payments from Apple; Raising FVE to $80. See Updated Analyst Note from 01 May 2019

Qualcomm reported fiscal second-quarter results consistent with our prior expectations, while providing guidance that included one-time revenue related to the recent settlement with Apple and its contract manufacturers. After adjusting our model to include Apple licensing payments starting next quarter, as well as Qualcomm regaining modem share in the iPhone starting in 2020, we are raising our fair value estimate to $80 per share from $72. Despite the positive changes, Qualcomm is not immune to the current smartphone weakness plaguing the semiconductor market, as management is lowering its 2019 global 3G/4G/5G forecast by 50 million units to a midpoint of 1.85 billion units due to persisting weakness in China and a lengthening of handset replacement cycles, attributed to a pause in upgrades in advance of 5G rollouts. We remain positive on narrow-moat Qualcomm’s prospects in 5G and return to normalcy in its licensing business (QTL), though Huawei remains in dispute. Nevertheless, shares appear overvalued following the meteoric rise following the settlement with Apple, as we think implied growth rates may be too aggressive.

Second-quarter sales came in at nearly $5 billion, down 5% year-over-year as chip sales (QCT) fell 4% and QTL sales fell 8% due to broad weakness in the smartphone space. Positively, QTL benefited from a $100 million catch up payment from Huawei, while Qualcomm should receive another $150 million payment next quarter under its interim agreement. We believe Qualcomm should be better positioned in ongoing negotiations with Huawei following its settlement with Apple. QCT EBT margins were 14.6% during the quarter, down 100 basis points sequentially due to lower product volume. Management expects litigation cost savings to be partially offset by increased investment to support Apple’s 5G iPhone ramp in 2020.

Revenue for the third quarter is expected to be at a midpoint of $9.7 billion, including a $4.6 billion one-time payment from Apple. QTL sales (excluding the one-time payment) are expected to be around $1.3 billion, including Apple royalties for the first time in nearly two years. The firm’s estimate of an incremental $2 of ongoing EPS related to the Apple settlement includes future royalties from Apple and product shipments once Qualcomm is fully ramped to sell 5G modems into iPhones to be introduced in the Fall of 2020. We anticipate this incremental $2 EPS to contribute fully to Qualcomm’s fiscal 2021 results.

Assuming roughly 400 million iPhone units sold for which Apple did not pay Qualcomm royalties, the $4.6 billion catch-up payment implies $11.50 in royalties per iPhone, which is relatively consistent with our estimates. We expect Qualcomm will regain about 25% modem share in the iPhone to be launched in 2020 that will likely be 5G. Beyond fiscal 2020, we assume Qualcomm’s modem share in the iPhone tracks upwards toward 85% by fiscal 2022.

We note Qualcomm appears well-positioned to capitalize on the nascent 5G opportunity, with content in early 5G phones. As 5G ramps, we also think the firm will benefit from both device and chipset ASPs increases, particularly as Intel exited the 5G modem space for smartphones. While margins will benefit from the Apple settlement (higher device royalties for QTL), management also suggested additional opportunities to capture broader product content at Apple. We assume this would be related to RF front-end products (RF transceiver, RFFE components, and antenna modules), for which Qualcomm is already garnering traction with upcoming launches of sub-6 gigahertz and millimeter wave 5G devices. Lastly, while the firm still awaits a ruling in the U.S. FTC case, we think the Apple settlement is a positive indicator for Qualcomm’s QTL business model to remain intact.