Go All In With Qualcomm's Chips

Tickers in this Article: QCOM, AAPL, TXN, MOT, ERIC, NOK, T, RIMM

Qualcomm (NYSE:QCOM) continues to amaze skeptics with its share performance. Gaining ground since January, when it traded at around $36.00, Qualcomm's stock catapulted to over $56 in August before settling at $52.65 on the last day of trading for the month.

At first glance the shares look richly priced. At 23.7-times 2008 earnings, it trades well above the sector's price/earnings ratio of 17.7 and the S&P 500's forward earnings multiple of 15.5. In most cases, I would steer clear of stocks that reach such dizzying heights so quickly. But right now I'd say Qualcomm is probably an exception to the rule. Given the company's growth outlook, the price premium has merit. Positive developments could drive the stock upward further.

A Bet on 3G Wireless
For starters, I am excited about the third generation (3G) high-speed phones that both Apple (Nasdaq:AAPL) and Research In Motion (Nasdaq:RIMM) are bringing to market. Both companies will pay Qualcomm royalties on patents for the use of its WCDMA-based technology in the 3G phones. Indeed, the growing adoption of 3G wireless technologies plays in Qualcomm's favor, prompting management to up estimates for the coming quarter and for all of fiscal 2008 despite the weak economic backdrop. (Explore the controversies surrounding companies commenting on their forward-looking expectations in Can Earnings Guidance Accurately Predict The Future?)

Demand for its mobile chipsets for WCDMA 3G-based wireless technologies will likely gain further momentum after 2008 and open up new revenue opportunities. Its media and mobile video initiatives are expected to gain traction. AT&T (NYSE:T) has adopted the Qualcomm MediaFlow system for delivery of its broadband wireless video services.

The Start of a Beautiful Relationship
The end of a long-running legal fight with Nokia (NYSE:NOK), which controls about 40% of the mobile phone market, positions Qualcomm as a key supplier of advanced wireless technology licenses and could boost its share valuation further. Nokia's plan to license Qualcomm patents for its next mobile phones could ultimately make Qualcomm's technology a global standard that other phone makers such as Samsung, Motorola (NYSE:MOT) and Ericsson (Nasdaq:ERIC) may have to follow. Even better, peace with Nokia may prompt the Finnish giant to buy Qualcomm's chipsets for its WCDMA phones. Right now Nokia buys its chips from Texas Instruments (NYSE:TXN). A chip deal with Nokia could be the spark that really sends the shares flying.

Unlike many other hi-tech shops, Qualcomm has a sparkling balance sheet, with cash and equivalents of $11.5 billion with zero debt. With Qualcomm’s strong business model, which generates significant free cash flow, going forward you can expect the board of directors to return more cash to shareholders.

Of course, Qualcomm is not risk-free: 3G growth rates, for whatever reason, could fail to meet expectations, Texas Instruments' on-going push into CDMA could hurt pricing, and customers may attempt to diversify chipset suppliers. All the same, Qualcomm is probably one of the best ways to invest in wireless telecom growth. Even with the stock trading at a sizable premium, it looks tempting.

By Ben McClure

Ben McClure is director of McClure & Co., an independent research consultancy. Before founding McClure & Co., Ben was a highly-rated European equities analyst at London-based Old Mutual Securities. He also spent several years as a business/technology journalist at the Economist Group. McClure graduated from the University of Alberta School of Business with an MBA.

Type

Overnight avgs