Qualcomm Inc. (NGS: QCOM) is capping a strong stock year with some recent pressure on the shares. Various media sources have reported that Apple is seeking to develop and deploy its own baseband chips, eventually displacing Qualcomm’s mobile modems in its iPad and iPhone products.
Development of in-house modems has been anticipated following Apple’s purchase of Intel’s baseband business, which closed in August 2019. Qualcomm basebands returned to Apple after a two-cycle hiatus. Apple is one of very few customers that does not use the full computing and apps-processing power of Qualcomm’s Snapdragon chipset in its smartphones. Apple is a volume smartphone producer, and its revenue contribution is again meaningful for Qualcomm; but margin on modems is much lower than that on advanced Snapdragon products.
In our view, Qualcomm will be replacing lost thin-modem revenue with increasingly higher-priced and higher-margin Snapdragon apps processor revenue. Tear-down and bill-of-materials checks suggest that selling prices have moved up meaningfully for Qualcomm’s 5G Snapdragon products, which are used by over 100 Qualcomm customers, and should move even higher in coming generations.
Based on the contracts signed between Qualcomm and Apple in April 2019, Qualcomm will be retaining the rich royalty stream from Apple’s use of intellectual property. Although full analysis of the implications of an Apple exit are not clear, we believe Qualcomm’s chip business will withstand the Apple revenue loss, while overall margins could potentially improve.
We have noted that, with the Huawei signing, the Apple licensing agreement, and the appeals court victory, Qualcomm – which has been in constant litigation in the two decades we have followed the company – appears to have exited that phase of its existence.
Qualcomm hit an all-time peak price of $158 on 12/8/20, but has since sold off by about $10. According to a story published in Bloomberg on 12/10/20, Apple has begun to build its own baseband processors for future devices. The news was revealed to Apple employees during a virtual Town Hall-style meeting by SVP of Hardware Technologies Johny Srouji.
The news was anticipated, although timing was never certain and it remains uncertain now. Apple, after a bitter and multi-continent court fight, struck a comprehensive agreement with Qualcomm in April 2019 that included a royalty licensing deal, semiconductor supply agreement, and dismissal of all litigation between the two sides.
Apple appears to have determined that Intel, its modem supplier for 4G devices, would not have a 5G modem ready in time for the anticipated iPhone 12 launch in fall 2020. Apple was also planning to cut ties with Intel for it CPUs used in Mac PCs. Apple agreed to purchase Intel’s baseband business for about $1 billion in July 2019 and closed that deal in August of that year.
Based on the Bloomberg article and other sources, we believe the Apple 5G modem may first appear in a limited set of iPads late in 2021. Assuming the chips work as intended, they could potentially be ready for Apple’s fall 2021 launch of its second-generation 5G iPhones; we believe a more likely target would be the fall 2022 iPhone launch.
For Qualcomm, losing the recaptured Apple business would represent a meaningful hit to revenue. Apple produces about 200 million iPhones annually. Revenue from Apple was more than 10% of Qualcomm’s total fiscal 2020 revenue of $23.9 billion, or about $2.6 billion at an estimated 11% of total. We believe more than half was from licensing, with the remainder from sales of modems for iPhone 12 family phones. We estimate that Apple represents about $1 billion of semiconductor revenue for Qualcomm’s QCT business.
Apple signed a six-year licensing deal with Qualcomm in April 2019. For fiscal 2020, Qualcomm’ margin from its licensing business (QLT) was 68.5%. Qualcomm’s margin on QCT, by contrast, was 16.8%. Thus, the two Apple revenue streams (chips and licensing) represent very different profit contributions for Qualcomm, and the more profitable stream is not in jeopardy.
We believe Qualcomm’s margin on modem sales to Apple was less than QCT’s margin, given Apple’s ability to drive a bargain on volume purchases. The iPhone family appears to use X55 modems from Qualcomm; based on iFixit teardown analysis; the X60 was introduced after the iPhone 12 launch. The less-powerful 5G chip is X52, while Qualcomm’s most advanced modem at present is X60.
The X55 is integrated with Snapdragon, thus driving up Apple’s costs to use the X55 (even though Apple is not using Snapdragon’s computational power). The upcoming Snapdragon 875 chipset may have the option to include or exclude theX60 modem. That may make it easier for Qualcomm to retain its socket for a stand-alone X60 in the iPhone 13 (assuming the business is not fully displaced by an in-house Apple chip).
Qualcomm entered its quiet period on 12/14/20, ahead of 1Q21 earnings on 2/3/21, so confirmation of our analysis is unavailable until that time. Based on our earlier discussions with management, we believe the vast majority of Qualcomm’s QCT revenue comes from Snapdragon sales. Besides Apple, other 10%-plus customers in FY20 included Samsung, Oppo, Vivo, and Xiaomi; Huawei has now joined that group, meaning all major smartphone makers are major customers.
Whereas Apple uses its own A-series Bionic chips for applications processing, all these phone makers use the entire capability of Snapdragon, along with the related software stack, in their phone. Even Samsung, which uses its own Exynos apps processors in some devices, used a Snapdragon 855 in its Galaxy S10 (last year’s early 5G phone). This year’s Galaxy S20 features a Snapdragon 865 with a bill-of-materials price upwards of $100 (Samsung’s BoM value for its own less-advanced Exynos chips is about $80).
Note that Qualcomm is all over Samsung’s phones. In addition to Snapdragon, the S10 contained audio codecs, transceivers, RF, and power modules from Qualcomm. All in, Qualcomm commanded nearly 40% of the bill of materials on the S10. We believe Qualcomm’s percentage bill of materials in S20 may be comparable. For less advanced companies that don’t have the option of their own apps processors or basebands, Qualcomm’s bill of materials percentage could be higher.
Our analysis also suggests that Qualcomm is taking a two-track approach to driving revenue in its QCT business. On one track, Qualcomm may be offering discounted prices to phone makers using its mid-range Snapdragon 765 chipset, in order to drive volume in mid-range 5G devices. On the other track, Qualcomm is holding firm on prices for it snapdragon 865 currently used in Galaxy S20.
According to the tech press, which is not always reliable, prices for the upcoming Snapdragon 875 may set a new and much higher bar. A story on WCCFTech, under the appropriate heading ‘mobile: Rumor,’ pegged the Snapdragon 875’s price as much as $100 more than the 865, in the $250 range. Note that this is a complete phone-in-a-chipset, with modem, apps processor, graphic processor, RF, and a host of other capabilities.
We believe Qualcomm will offer a range of SoC and modem bundling options to drive sales of 5G devices across the mid-range through premium devices, though not at the lower tier.
In summary, we believe Qualcomm will be able to withstand the loss of Apple revenue if it were to lose its mobile modem socket in future iPhones. The stand-alone modem carries lower margins than a full Snapdragon chipset. The more significant revenue component from Apple is licensing revenue, which is high-margined. Most important, Qualcomm derives the bulk of handset-related revenue from users of its integrated Snapdragon chipsets; and prices for Snapdragon are stepping up meaningfully in the 5G era.
EARNINGS & GROWTH ANALYSIS
Excluding the Huawei payment, 4Q20 non-GAAP revenue of $6.5 billion. Non-GAAP revenue for 4Q20 was meaningfully above the $5.9 billion; revenue also topped the $5.93 billion consensus forecast.
For fiscal 1Q21 (calendar 4Q20), Qualcomm expects revenue of $7.8-$8.6 billion.
We are not yet factoring in any decline in revenue or margin implications related to potential lost Apple business, as the timeline for any such transition is uncertain. Our FY21 non-GAAP forecast is $7.25 per diluted share. Our preliminary non-GAAP EPS projection for FY22 is $8.11 per diluted shares.
MANAGEMENT & RISKS
While the federal appeals court for the ninth circuit has overruled the FTC decision, there remains a risk that this ruling could itself be overturned on appeal. We see that risk as low, however, given the strong impetus at the DoJ to champion U.S. leaders in 5G.
On December 14, BUY-rated QCOM closed at $146.29, up $2.01.