Qualcomm and Qorvo Face Challenges in Smartphone Market

Qualcomm: Diversification Not Enough To Offset Losing Samsung And Apple (NASDAQ:QCOM)

Due to the threat of losing Samsung and Apple's business, I will call a 'Hold' for this stock. Qualcomm Incorporated (NASDAQ:QCOM), one of the leading semiconductor chip-making companies in the world, is currently facing challenges as two of its major customers, Apple (AAPL) and Samsung (OTCPK:SSNLF), are backward integrating into its business. While Qualcomm is diversifying its business into PC and Automotive to offset the threat of losing significant revenue from its two biggest customers, these efforts won't fully compensate for this impact. Therefore, I'm calling for a 'Hold' on this stock. The rise of EVs has resulted in an industry shift, which I term the 'Smartphonification of the Automotive Industry.' This shift, driven by the advanced technology inside electric vehicles, has prompted traditional automakers to integrate cutting-edge semiconductors into their cars to improve their experience and reliability. Qualcomm's expertise in the smartphone market positions it well to capitalize on this transformation. So, what expertise makes Qualcomm such a unique company in this evolving space? That is, Connectivity and Efficient and High-Performing System-on-Chips (SOC). For carmakers' ultimate ambition of a fully autonomous vehicle to take place, these vehicles must first become 'smart.' To be smart, they need access to vast amounts of data that can only be stored in the cloud. Thus, they are strong at their industry-leading 5G Modems, and this is evident with Apple, which, despite its access to vast resources, is struggling to create its own 5G modem in-house that can replace Qualcomm. Additionally, features such as map navigation, fleet management, safety, emergency alerts, over-the-air updates (OTA), Vehicle-to-Everything (V2X), and artificial intelligence require reliable and secure connectivity. Qualcomm's expertise and scale in smartphone connectivity will effectively translate into this business, providing a significant advantage over its competitors, who rely on other vendors to provide this function. Qualcomm is also well positioned to take advantage of cars becoming more software-defined with Digital Cockpit infotainment experience and Advanced Driver Assistance Systems becoming more reliant on leading-edge semiconductors to function properly and safely. With digital cockpit now having similarities with smartphones in features such as user interface, customization, voice controls, OTA, and software applications, Qualcomm is in a great position to provide solutions to these demands with their Snapdragon System-on-Chip (SOC), which has a strong foundation from the smartphone industry. Furthermore, one of the leading operating systems in the digital cockpit is Google's (GOOG) Android Auto, which Qualcomm has a long history of working within its smartphone business. Qualcomm SVP Nakul Duggal highlighted how their exposure in the smartphone business effectively translates into automotive. Yes. I think the digital cockpit business, we are very we are very bullish on for a couple of reasons. There are actually several reasons. I think, first of all, there are not many companies who have the type of exposure that Qualcomm does where we are very heavily invested in the smartphone space where the world changes on a 12, 15-months cadence, brand-new consumer technology has to be dealt with. You have to be in advanced process nodes. You have to deal with a variety of different software ecosystems, a global footprint. So it's a very fast-moving market and the digital cockpit is starting to care about all of the same types of things. He is right. Their ADAS competitors, such as Mobileye (MBLY), didn't come from an industry similar to what the automotive industry is becoming-an industry increasingly resembling the smartphone market, where Qualcomm is very strong. This results in significant cost savings for automakers since they don't need to integrate multiple chips to run specific functions. Instead, multiple operating systems run on different virtual machines-hypervisor made this possible-such as those for infotainment, ADAS, and safety monitoring, can run on a single Snapdragon SoC rather than requiring a separate chip for each operating system. Furthermore, a high-performance SOC is needed to run these multiple platforms reliably, which Qualcomm is well-known for. This can result in a simpler and streamlined design process since fewer parts must be considered, adding further savings for the automakers. Interestingly, Intel's automotive presentation at CES discussed how cars are shifting towards architectures similar to PCs and smartphones. Automotive used to be an unattractive market for semiconductor firms due to a lack of scale and standardization. There are a large number of car variants with different kinds of designs, which require different kinds of specialized chips. Thus, the unit volume required by the semiconductor firms for a target market to be economically viable isn't there. Future cars being more software-defined will fix this issue, as the new architecture will require more standardization. Developing software for automotive applications requires a standardized platform or operating system to simplify the development process. A platform with wide adaptability is necessary, as developing software for a small user base doesn't economically make sense. Qualcomm's prospects in this business are bright, as features like ADAS, which are crucial for safety, will demand significant research and development. ADAS will require specialized expertise, and OEMs that lack the necessary scale and foundational semiconductor and software expertise will struggle to compete in this area due to the high costs involved. Furthermore, for safety reasons, the certification process for cars is more rigorous than in the consumer electronics market, creating a high entry barrier, as the OEM certification and validation process for semiconductor firms can take multiple years. Recent news on General Motors (GM) laying off 1,000 software engineers confirms this, and I expect layoffs from others to follow. Qualcomm is bullish in this market and forecasts its automotive business to grow at a CAGR of around 24%, from $1.3B to above $9B in revenue from 2022 to 2031. Although ADAS is a young and high-growth market, advancing its capabilities along with autonomous driving will require significant R&D spending, particularly due to its crucial role in ensuring the safety of people inside and outside the vehicle. Regardless of any industry, this is typical for a high-growth one, especially in technology, where companies must invest heavily in R&D to maintain their competitive edge during the early stages of the industry's development. This is evident in Mobileye's financial statements, where they spend significant revenue on R&D. As a result, Qualcomm may not enjoy the same level of profitability in the automotive industry as it has in the smartphone industry for the foreseeable future. Additionally, the significantly longer lifecycle of cars compared to smartphones means that Qualcomm's scale won't be as beneficial in the automotive industry as it is in the smartphone industry. Moreover, competition is not standing by; some of their competitors, such as AMD and Intel, are starting to enter this industry. Their expertise in SOC from years of competing in the PC market can also effectively translate into this industry. Despite being one of the leading companies for smartphone connectivity and SOCs, Qualcomm is currently at risk of losing significant revenue from Apple and Samsung. So why are Apple and Samsung eager to replace Qualcomm's chips with their in-house ones? The differentiation in consumer electronics has shifted from hardware to software, and the hardware is reaching a point where it just needs to be 'good enough.' It no longer makes sense to pay a premium for that extra performance. During the heyday of Moore's Law, when semiconductors achieved double-digit performance gains with each new generation, it was easy to convince consumers to upgrade, as the tangible performance improvements from the latest against the previous generations were easily distinguishable. However, with the slowdown of Moore's Law, semiconductor companies like Qualcomm, Apple, AMD (AMD), and Intel (INTC) are increasingly struggling to achieve significant performance gains with each new release. This is evident in recent offerings from AMD and Apple, where performance improvements are minimal compared to their predecessors. Despite Apple's struggle with its 5G modems, they recognize that Qualcomm's 5G modem has minimal contribution to its differentiated user experience, and their customers won't even notice, even if they use a different 5G modem. Apple is following the same playbook here as they did with Intel. They could use their in-house 5G modem as a marketing theme for future iPhones, just like what they did with M1, which revitalized the MacBook. Furthermore, if we look from the consumer standpoint, the experience of using older iPhones, using older 5G modems, when using apps that require connectivity is subjectively pretty much the same. The average consumer won't notice the difference. Apple just needs to make sure that replacing Qualcomm's 5G modems won't significantly affect the user experience. Moreover, Samsung understands that while Qualcomm's Snapdragon SoCs offer the best performance, they only need to get close enough in performance to maintain a comparable user experience. Their latest Exynos 2400 is very competitive against Qualcomm's latest Snapdragon 8 Gen 3. As a result, Samsung has positioned its Exynos chips in the lower tiers of its flagship s24 models while reserving Qualcomm's chips for the highest-tier models and regions. Furthermore, it is rumored that they will exclusively use their Exynos on some of the lower flagship models, such as the base model of the S25 phone. Apple and Samsung know that outside of the enthusiast class, where sophisticated buyers usually reside, most of their customers care more about the improvements in user experience than what components are used inside the phones. Furthermore, the demand for more computing power in software has not kept pace with the improvements in hardware, leading to a performance oversupply. For example, productivity applications like Excel, Word, and PowerPoint continue to run smoothly on three to five years old CPUs. Similarly, the user experience of the latest iPhone can be easily matched by older models, such as the iPhone 11, 12, and 13. However, Qualcomm has shown in the past that it is a fierce competitor and highly innovative. Despite repeated attempts by Apple and Samsung to move away from Qualcomm's products, they have consistently failed to do so. Thus, I won't be surprised if they continue to do so. Before I delve deeper into this topic, I have made a significant effort in my previous Intel articles to explain why ARM (ARM) is less of a threat to x86 in the PC market than people are making it out to be. I would encourage you to read them. Although the PC market has lower growth and lower TAM than smartphones, one crucial difference makes it such an attractive business over smartphones: OEMs' incapability to backward integrate into chip-making. OEMs like Dell (DELL), HP (HPQ), and Lenovo (OTCPK:LNVGY) have operated as integrators of outsourced hardware components since personal computers became mainstream. These OEMs have never attempted to create high-value components, such as CPUs, unlike Apple, which can integrate backward into high-value components like CPUs and modems. Based on their recent cost-cutting, such as HP's 'Future Ready Plan' and Dell's focus on AI, it is unlikely that these OEMs will change their approach to the PC business anytime soon, if ever. According to Morgan Stanley, ARM's market share in the PC market will be 14% by 2026 from 0% in 2023. Furthermore, ARM CEO Rene Haas predicts that in 2029, ARM's market share in the Windows PC will be 50%; this is exaggerated and hard to achieve in a mature and slow-growing industry. Before I elaborate, let us quote legendary Intel CEO Andy Grove. Market share is gained and lost at times of transition. Times of transition occur when innovation disrupts incumbent products by offering significantly lower costs, higher performance, greater ease of use, and other advantages, leading to a shift in consumer preferences and a redefinition of the marketplace. Famous examples of disruptive innovations include the transition from mainframes to personal computers and from feature phones to smartphones. However, ARM is not a disruptive innovation for the x86 architecture because it doesn't introduce something fundamentally new to the market. ARM's advantage in efficiency can be effective in the laptop segment of the PC, but AMD and Intel are now addressing this with their upcoming chips. The competition between ARM and x86 moving forward will be about weighing the pros and cons of both architectures, where choosing x86 may compromise a bit of efficiency in exchange for greater performance and vice versa. Despite this, ARM has a place in the PC market. However, I still see the x86 architecture continuing to dominate the PC for the foreseeable future due to decades of software development that has been put into this architecture. For valuation, I will use the Discounted Cash Flow method. I will present two models: one in which Apple continues to use Qualcomm Modems and another in which it does not. On my revenue assumptions, according to IDC, smartphone shipments from 2024 to 2028 will grow at a CAGR of around 2.3%. Since these are shipments, I will settle for a CAGR of around 5% for Qualcomm's revenue to account for its pricing power. We will use Qualcomm's forecast for automotive, which I mentioned earlier. I will assume that Qualcomm will lose around $8 billion in 2027 due to Apple not extending its modem deal. As for licensing revenue, this usually correlates with smartphone TAM, so I will assume a 5% growth. For EBIT, I will use their historical EBIT margin based on their historical revenue levels. As for others, such as D&A and CAPEX, Besides not being as capital intensive as the rest of the semiconductor industry, based on their recent analyst presentations and interviews, I believe that Qualcomm won't partake in a strategy that will require significant investment moving forward. Therefore, I will use D&A and CAPEX as a percentage of sales based on their historical averages. I believe Qualcomm is selling at fair value at its current price. With Qualcomm's management providing a forecast for its automotive business and Apple's expiring modem deal in early 2027, these factors have already been priced into the stock. The only factors that, I believe, aren't priced are the potential further loss of the Samsung business and their prospect in the PC market due to uncertainty. Considering what I said about Samsung and AIPC, I expect Qualcomm to gradually lose revenue at a consistent pace from Samsung moving forward and a continued dominance of the x86 architecture in the PC market. Therefore, I will call for a 'Hold' in this stock. The factors that will convince me to put a 'Buy' rating on this stock are the following: Factors that will put this on a 'Sell' rating are: Qualcomm is one of the industry's fiercest and most competitive semiconductor firms. However, despite its unfavorable market position-surrounded by companies with significant bargaining power and technological prowess-Qualcomm finds itself in a precarious situation where no innovation seems enough to compensate. Nevertheless, the management has strategically positioned the company for long-term success. Unfortunately, I prefer to buy the stock at a decent discount to compensate for the uncertainty that surrounds the Samsung business.

The Head-Scratching, Less-Than-Stellar Guidance From Qorvo (NASDAQ:QRVO)

We believe that management made a conservative estimate for its September guidance. Qorvo (NASDAQ:QRVO) reported strong earnings for the June quarter, but left analysts scratching their head with slightly lower year over year guidance. This guidance came after management had touted the marketplace with visions of continued ASP growth beginning in September from their largest customer, Apple (AAPL). The strong June quarter didn't overcome the perceived weak guidance rather left us cold until we made a deeper scratch. This writing continues our generally bullish stance on the company, being, Qorvo: Report Yields A Clearer Picture For The Company And Mobile Devices. We are upgrading to a buy. Maybe we should stop scratching and hit the keyboard. Would you join with us? Now, put that hand down. Qorvo, for the 1st time or maybe just in a long-time, included a really nice summary. We are adding relevant portions. The summary includes: the primary end markets are "automotive, consumer, defense and aerospace, industrial and enterprise, infrastructure and mobile." Each market is "underpinned by global megatrends, including electrification, connectivity, mobility, sustainability, datafication, and AI." Continuing, and for the techies, management added, "Our markets are characterized by multiyear upgrade cycles, including 5G Advanced, Non-Terrestrial Networks, Wi-Fi 6 and Wi-Fi 7, DOCSIS 4.0, Matter, Ultra-Wideband and others." Several technical issues drive changes: low latency, speed, bandwidth, and power efficiency. One massive coming change, AI, consumes massive amounts of power, a problem especially with battery powered products. Low power usage will become more and more and more and more important going forward. The businesses are divided into three sectors, ACG, HPA and CSG. The company reported EPS of $0.87, above the high end, with revenue of $887 million, a revenue increase of 36% year over year and non-GAAP margins at 41%. Cash on hand equaled $1.1 billion with debt at $1.5 billion. $27 million of the 2024 notes due at year's end were paid. Inventory remained relatively flat at $727 million. Materials needed for the seasonal ramp with Apple are included in the flat value. The company purchased $125 million worth of stock. Finally, the yearly tax rate will range between 10% - 12%. Qorvo ramped several new products into several customer ramps including: Looking into the future for each business segment, management noted: In our view, Qorvo's conferences always loaded with techie like comments indicates the importance of top end technologies and products. On the current market buzz subject, questions relating to AI, most easy to predict, surfaced. In answer, Robert Bruggeworth, CEO, stated, "And as far as AI goes, I think, we're taking more of a conservative approach. I mean, clearly, we saw that in what Samsung released in the S24. And just to remind the group, we've got excellent dollar content in that and they had a pretty nice ramp. It wasn't tremendous above what expectations were, but they did a good job this year with the S24. Whether it was due to AI or not clearly sure. And as far as our largest customer goes, since they haven't released their next-generation phones, we're not going to comment. But I think as an industry, it would be wonderful if that AI came out, it was very useful for users and reduce the replacement cycle time so that we would see an uplift. . .. But that's not what we're modeling at this time. Qorvo seems to be very conservative compared with Skyworks Solutions' recent comments. They will believe it when they see it. But new technologies with higher ASPs are coming, regardless. During the call, a few comments appeared on the marketplace including this bit of in-site. "In calendar '24, we expect Android 5G unit volumes to grow greater than 10%. We are also positioned to grow with 5G Advanced, which occurs with new releases of the 5G standard." On the mobile markets, management noted: "Turning to mobile, which is primarily smartphones and tablets, our largest opportunity remains at our largest customer. We are investing in multiple multiyear programs to increase our content and continue to grow revenue with this customer." With respect to Android, management also made this comment: "Within the Android ecosystem, Qorvo remains the primary RF supplier. We collaborate with Android OEMs on their product road maps over multiple years and we are positioned to drive growth as 4G devices move to 5G . . ." Similar to Cirrus Logic (CRUS), Qorvo seeks long-term relationships with real roadmaps for growth. These strides are measured and steady. In the past, this 10% comment of growth in 5G conversion has appeared several times. The comment confirms this expectation at least for this year. Now, let's comment on the guidance which triggered an interesting back and forth between the analysts and management. The report guided September at $1.05 billion with non-GAAP margins between 46% and 47%. Margin improvement is expected to continue going forward as communicated at the last Investor Conference. Before continuing, a past look at September 2023 guidance must be included given at $1 billion. The September release posted an actual at $1.1 billion, higher by 10%. On a revenue basis, the company guided at $1.025 billion a very slight increase year over year. It is with this issue that analysis pounced. From a very carefully worded question, Christopher Rolland of Susquehanna, asked, "I guess, maybe getting back to the September quarter. Just a question I keep getting asked from investors is around revenue still being down year-over-year. And I think the assumption is you have content growth at your largest customer. So and perhaps we have an AI refresh cycle. I know you're conservative there. I appreciate that conservatism. But still why not growth or at least flat year-over-year particularly in mobile?" Grant Brown, CFO, answered with the same level of tact that "the slight decline is principally related to smartphone revenues. This change is based on the total smart phone marketplace, and we are being a little conservative." Then, with an additional one from Dave Fullwood, Senior Vice President, Sales & Marketing, came this, "We actually have purchase orders on the books now and that will just start to ramp at the very end of this quarter. So that will ramp up as we go through the balance of this year and into next year. So we're -- it's kind of a timing situation happening there in the Android ecosystem." The answer included a commentary discussing a ramp peak with other Android vendors earlier in the year. Our take: management guided September with extreme conservatism. Either September picks up a larger piece from the new phones or the revenue slides into December beefing that quarter. Over time, it makes little difference. We believe that the market mistook the real issue once again, when it sold off the stock price steeply the following day. The call entertained additional questions on this issue being answered with assurance of additional content with Apple, but not enough to overcome other weaknesses. The company offered a few comments opening more color into next year. When asked about Apple's potential with providing its own modem chip in a test phone, the answer came back with a it won't likely impact a path to higher ASPs. This answer came with a significantly higher level of confidence than when Skyworks was asked at its conference. Qorvo has developed a tight long-term plan with Apple. It seems integrated parts are at the heart of this development for saving board space, lowering power usage and most generally lowering costs. In the past, with Apple talking about using its own modem, market reactions have been negative. Some analysts believed that the long ago new hires from the RF world signaled Apple's intent to develop and use its own RF products. RF is a very difficult product; one Apple would take on huge risk in developing its own. It makes no sense. What makes sense is that Apple will develop a product strategy and companies like Qorvo or Skyworks in parallel will develop the products. Regarding next year, Qorvo expects revenue increases with China-based automotive including V2X FEMs and Ultra-Wideband portfolios. We aren't certain of the level of revenue increases from this addition. Next. a chart generated from TradeStation helps investors understand possible prices. From the chart, Qorvo seems stuck trading between $100 - $125 for now. We don't know of anything that would change this at least through the next earnings. We are carefully watching the price action. The break of the 18 SMA, the magenta line, puts an upward pattern back in place. One major risk is a recession with the latest jobs report pointing square at one with a level of sting. If the market senses this, it will tank taking in general all stocks with it. Another risk might occur if China decides to capture Taiwan. We can't imagine this positive. But clearly, in our view, management gave very conservative guidance. Either September will be stronger or December much stronger, or both. We expect a price bump with the early November reported September quarter. At this point, we have short $115 January calls plus several $120 and $125 short November calls. We plan on moving up the November expiring strike price toward $130 sometimes in October. We expect to lose the stock associated with the $115 calls. One last interesting tid-bite of positive news was found in this recent release. From Seeking Alpha, '"Morgan Stanley noted that Apple's (NASDAQ:AAPL) iPhone 15 builds were stronger than expected in July, and that momentum seems to be building into the iPhone 16 launch. And this, "The 54M iPhone builds represents an all-time September quarter build record (4M units higher than the previous record) and would imply September quarter iPhone shipments of 55M units (+10%year-over-year), 5% above Morgan Stanley's current Sept quarter shipment forecast (of 52.5M units) . . . " Keeping this in context, Counterpoint estimates a normal September unit sale at slightly less than 50 million. We believe that Qorvo's management had not included this late quarter surge into its guidance. For Qorvo, this is worth nearly $50 - $75 million in additional revenue. In-spite of risks, Qorvo, in our view, remains a buy in particular at its relative cheap price in context with the chart. It is also highly likely to beat by a large margin the September guidance. This is a long-term, decades long, incremental growth story. Picking reasonable prices in which to buy and add will come along. We upgrade to a buy rating, but patience is still in order. The recent Fed announcement burst will die off likely offering lower entry points. Also of note, at times our rating toggles between buy and hold with stock price being the driver. There is no need to continue head scratching, problem solved.