An Array of Uncertainties for Qualcomm

Qualcomm QCOM reported fiscal third-quarter results that were negatively impacted by challenging industry conditions. Furthermore, we expect a host of issues to compound in the coming quarters that will exacerbate Qualcomm's financials. In addition to the May 22 ruling by U.S. District Judge Lucy Koh ruling that Qualcomm unlawfully suppressed competition in the market for smartphone chips and used its dominant position to extract excessive licensing fees, the firm is also facing Huawei-related headaches and headwinds associated with the transition from 4G to 5G. Although Qualcomm has a strong position with 5G, many of the firm's customers (especially in China) are working through existing 4G inventory and curbing second half 2019 4G launches as all focus moves to 5G launches for early 2020. Management anticipates the first calendar quarter of 2020 to be an inflection point for Qualcomm, with which we concur. We are maintaining our $72 fair value estimate for narrow-moat Qualcomm amidst an array of uncertainties, and we recommend prospective investors steer clear of shares at current levels.

Third-quarter sales came in at $9.6 billion, with $4.7 billion associated with the Apple settlement. Chip sales were down 13% year-over-year at $3.6 billion due to the 4G to 5G pivot (particularly in China) and Huawei export ban (which also led to Huawei shifting their emphasis to building domestic China market share with products that Qualcomm does not see neither product nor licensing sales). Licensing, or QTL, revenue came in at $1.3 billion, which was down 10% year-over-year due to broad market weakness, but positively included current period Apple royalties and the last $150 million interim payment from Huawei. Concerning the latter, Qualcomm continues to negotiate with Huawei on a license agreement. With the current export ban and ruling against QTL, we do not expect the dispute to be resolved anytime soon, with management excluding Huawei royalties in its forward guidance.

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