Qualcomm Royalty Rates Improve, Capex Jump in 2011

Qualcomm (NASDAQ:QCOM) recently announced its FY Q1 2011 earnings, in which it provided an outlook for 2011. The notable positive here is the higher expected royalty rate in 2011, which reverses the trend of declining royalty rates in recent years. ^[1] The tripling of capital expenditures that the company expects in fiscal year 2011 compared to 2010 also stands out to us, and we discuss the potential impacts of these below. ^[2] Qualcomm competes with other chip makers like Texas Instruments (NYSE:TXN), Broadcom (NASDAQ:BRCM) and Infineon (PINK:IFNNY), and we have a $53.82 Trefis price estimate for Qualcomm stock, which is around 4% below the current market price.

Can Qualcomm Sustain Higher Royalty Rates?

We estimate that the average royalty rate that Qualcomm charges mobile handset vendors has declined rapidly over the past few years from 4% in 2008 to 3.2% in 2010. According to the company’s outlook, Qualcomm expects the royalty rates to increase to 3.5% in 2011. ^[1] The company mentioned that one of the reasons for the uptick in royalty rates in 2011 is due to a resolution of a dispute with an unnamed licensee who has been underpaying royalties Qualcomm. This uptick will be reflected from FY Q2 2011 onwards. We are maintaining our current royalty rate forecast for the time being and plan for it reach around 3.2% by the end of Trefis forecast period.

Management also mentioned that the guidance excludes the positive outcome expectation of the ongoing arbitration with Panasonic. It mentioned that the first phase of the arbitration process issued an order that stated that Qualcomm did not breach its license agreement with Panasonic. Could these events be positive for the company’s royalty rates in the long term as well?

There could be an upside of around 10% to our estimate for Qualcomm stock, if the royalty rates continue its upward trend to reach around 4% by the end of Trefis forecast period.

Qualcomm’s Investment

Qualcomm expects capex to triple in fiscal 2011 compared to fiscal 2010. ^[2] This increase will primarily be related to $945 million investment planned for the construction of a new manufacturing facility in Taiwan for making Mirasol displays, which should be operational in 2012. Mirasol is a display technology used in e-Readers, tablets and smartphones. Qualcomm’s capex as a % of gross profits trend over the last few years has been volatile and has declined from 18% in 2008 to around 6% in 2010. However, we expect it to increase to around 14% in 2011 and then decline gradually to around 10% by the end of the Trefis forecast period.

However, if the company continues to make significant capex investments beyond 2011 as well, without the visibility whether these investments will produce significant revenue generation opportunities, it could create a negative impact on Qualcomm stock.

There could be a downside of 7% to our estimate for Qualcomm stock if the capex % of gross profits remains constant at 14%, instead of the decline that we forecast throughout the Trefis forecast period.

See the complete $53.82 Trefis Price estimate for Qualcomm stock.

1. See SeekingAlpha: Qualcomm FY Q1 2011 earnings conference call transcript [↩] [↩]
2. Mentioned in FY Q1 2011 SEC filing: “We anticipate that capital expenditures will be more than three times higher in fiscal 2011 as compared to fiscal 2010“ [↩] [↩]