Analyst Recommendation

SELL

PricingClosing Price: $42.70 (02/20/07)52-Week High: $ 53.01 52-Week Low: $ 32.76

Market DataMarket Cap: 70.73B Diluted EPS: $1.45P/E: 29.30Dividends: $0.48Div. Yield: 1.10%Payout Ratio: 29.00%

Profitability & EffectivenessROA: 13.18%ROE: 19.11%Gross Margin: 71.04%Net Profit Margin: 32.01%

Zaza Tugushiztgw3@mizzou.edu

Revised By:Madalyn Payne

Mepdh9@mizzou.edu

QUALCOMM, Inc.

Ticker: QCOMSector: TechnologyIndustry: Telecommunications EquipmentEmployees: 11,200

II. The Firm and its Market

Company ProfileQualcomm Incorporated designs, manufactures and markets digital wireless telecommunications products and services based on its code division multiple access (CDMA) technology and other technologies. The Company is organized into the following four business units:

Qualcomm CDMA Technologies develops and supplies integrated circuits and system software for wireless

voice and data communications, multimedia functions and global positioning

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I. Screening

Results of ScreenerStock screener provided by MSN was used to identify potential investment options for the Mizzou Investment Fund. The screener returned a list of 25 companies. After a brief overview of possible candidates, Qualcomm was selected for further research for its strong historical performance, unique technology and a growth potential rarely seen in a large cap company.

Screener ParametersThe following parameters were used in the screener.

Industry: AllS&P 500 Index Membership: YesMarket Cap: Large Cap

Dividend Yield: as high as possiblePrice/Earnings Ratio: as low as possibleRevenue Growth Year vs. Year: as high as possibleNet Profit Margin: as high as possibleDebt/Equity Ratio: as low as possible

A company meeting these criteria will be a valuable addition to the Mizzou Investment Fund and it will be consistent with the fund’s overall objectives.

Qualcomm Technology Licensing grants licenses to use portions of the intellectual property portfolio, which includes

certain patent rights essential to and/or useful in the manufacturing and sale of CDMA products

Qualcomm Wireless & Internet generates revenue primarily through mobile communication products and services,

software and software development

Qualcomm Strategic Initiatives makes investments to promote the

worldwide adoption of CDMA products and services

The contribution to 2005 revenues of each business units is displayed in the following chart.

Qualcomm markets its products through direct sales force, partnerships, and distributors in the United States, Europe, the Middle East, Argentina, Brazil, Canada, China, Japan, South Korea, and Mexico. The Company was incorporated in 1985 and is based in San Diego, California.

Current Events

PROS Qualcomm reaffirmed its 2007 outlook, with first-quarter revenue forecast at $2 billion to

$2.1 billion, the low end of a forecast by analysts polled by Thomson Financial Network. But the positive outlook for W-CDMA chip sales, particularly to Motorola Inc.1

Recent investments suggest QCOM is expanding their technology beyond cell phones into sensors, TV, and gaming

oVerizon Wireless is expected to offer mobile television services via Qualcomm MediaFlo network

Qualcomm acquired wireless Local Area Network provider Airgo Networks Inc. and the majority of RF Micro Devices Inc’s Bluetooth assets.

CONS The company's patent-licensing practices face legal attacks from Nokia, the highest-volume

seller of cell phones, and competitors that include Broadcom Corp. and Texas Instruments Inc.

Qualcomm seems to be the number one lawsuit target. Currently they are being sued or in a middle of 2 lawsuits with the possibility of another one coming from Korea.

oSteven Altman, Qualcomm's president, said in a conference call that the company plans to significantly increase its estimate for legal expenses this fiscal year, to counter what he called an "orchestrated" attack on the way Qualcomm does business.2

Market Position and Competition2

The market position of Qualcomm has been very strong. The Company started as a wireless tech firm that developed a superior digital wireless process called CDMA (Code Division Multiple Access). CDMA technology has become the leading standard in the United States. The rival technology used to carry voice signal across the network is TDMA, better known as GSM, and is a dominant technology in terms of current use worldwide.

The main difference between the two technologies is how the voice data is carried across the network. GSM divides the frequency band into multiple channels and stacks them together into a single stream (hence the term “narrow” band). CDMA allows multiple calls to overlay on top of each other with each call assigned a distinct “sequence code” to keep the signal distinct. As a result, CDMA allows greater frequency reuse, increasing battery life, improved rate of dropped calls and far greater security than GSM. That is one of the reasons that WCDMA technology, which is based on CDMA, is a basis for every 3G network built around the globe.

Qualcomm’s main competitors according to Yahoo Finance are Nokia, Texas Instruments and Samsung, a private company. However, this list of competitors does not include all rivals such as Broadcom and provides limited information on the nature of competition between these companies. For example, Nokia, the largest cell phone manufacturer, is not involved in making CDMA chips and pays license fees to Qualcomm for selling cell phones with CDMA chips. Texan Industries are a chip manufacturer and that’s the reason for their listing in the following table. Samsung, a manufacturer of cell phones and cell phone chips, is contracted to make CDMA chips for Qualcomm.

As the chart shows below, QCOM is the second largest in Market Cap and is leading its competitors and the industry in quarterly revenue growth. This large growth is in large part due to the increase in interest for 3G technologies which QCOM is the leading provider. QCOM is also dominating in the gross and operating margins categories as well. With a gross margin higher than its competitors, QCOM is able to spend more money on R&D to stay ahead of the industry.

DIRECT COMPETITOR COMPARISON  

QCOM NOK Pvt1 TXN Industry

Market Cap: 70.73B 91.17B N/A 45.02B 152.82M

Employees: 11,200 68,483 128,0001 N/A 240

Qtrly Rev Growth (yoy): 16.00% 13.20% N/A -3.60% 14.40%

Revenue (ttm): 7.80B 54.02B 78.99B1 14.26B 194.34M

Gross Margin (ttm): 71.04% 32.54% N/A 51.37% 36.87%

EBITDA (ttm): 3.44B 8.18B N/A 4.92B 11.30M

Oper Margins (ttm): 33.87% 13.35% N/A 23.62% 2.09%

Net Income (ttm): 2.50B 5.66B 7.49B1 2.64B 718.54K

EPS (ttm): 1.464 1.38 N/A 2.783 0.04

P/E (ttm): 29.17 16.66 N/A 11.16 26.62

PEG (5 yr expected): 1.17 1.55 N/A 1.31 1.58

P/S (ttm): 9.02 1.70 N/A 3.13 1.49

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NOK = Nokia Corp.

Pvt1 = Samsung Electronics Co., Ltd.

TXN = Texas Instruments Inc.

Industry = Communication Equipment

1 = As of 2005  

III. Economic and Industry Environment

According to the Value Line survey, Telecommunications Equipment Industry is thriving. Large telephone and cable companies continue to expand their local and long-distance calling and high-speed Internet networks. Wireless carriers are engaged in fierce competition to develop 3rd generation (3G) networks and increase their coverage areas. Telecommunication equipment providers along with telecommunication equipment manufacturers will reap significant benefits from continuous expansion of the entire telecommunications industry.

The telecommunications industry is a highly competitive market which requires a lot of R&D to stay on top of the industry. Many companies that enter this market do not make it; however, if a company is able to donate a lot of time and money on R&D their chances of becoming successful are good. Also due to the high competition and low success rate, the number of mergers and acquisitions in this industry has been increasing each year.

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Performance of Telecommunications Equipment industry is closely tied to the performance of the economy. The industry lagged behind the total U.S. market index following the recession but by the beginning of 2004 the telecommunications industry caught up and outperformed the market.

IV. Valuation

First step in valuation of Qualcomm was to calculate appropriate discount rate. The discount rate was calculating using CAMP formula.

Discount Rate = Risk-free Rate + Beta (Market Return – Risk-free Rate)

Beta = 2.4 (obtained by doing regression over the last 3 years)Market Risk Premium = 4.0%Risk Free Rate = 4.98%

Discount Rate = 4.98% + 2.4 x 4.0% = 14.58%

The discount rate seems reasonable given the stock price volatility and an overall riskiness of the telecommunications equipment industry.

Valuation model for Qualcomm has to be at least 2-stage growth since the company is in growth stage. The technology underlining its business model is expanding and becoming increasingly popular around the globe.

a) Owners’ Earning Discount Model

To calculate the 1st stage growth rate I took the average of analyst predictions for the next 5 years, 17.22%. To adjust for the 5 year growth rate instead of the 10 year growth rate I adjusted the excel spreadsheet to only calculate out to 5 years. To calculate the 2nd stage growth rate I stayed with a conservative rate of 4%. Warren Buffett Way Owners' Earnings Discount Modelassuming discount rate (k) of 14.58%

Owner Earnings in 2004:

Net Income $ 2,470,000,000.00

Depreciation $ 200,000,000.00

Amortization -

Capital Expenditures $ 576,000,000.00

Owner Earnings $ 3,246,000,000.00

Year:  2004

Prior Year Owner Earnings $ 3,246,000,000.0

First Stage Growth Rate (add) 17.2%

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Owner Earnings $ 3,804,961,200.0

Discounted Value per annum $3,804,961,200.0

Sum of present value of owner earnings $19,921,927,833.5

Residual Value

Owner Earnings in year 5 $ 7,183,847,437.8

Second Stage Growth Rate (g) (add) 4.00%

Owner Earnings in year 6 $ 7,471,201,335.4

Capitalization rate (k-g) 10.58%

Value at end of year 5 $ 70,616,269,710.32

Present Value of Residual $35,756,967,746.28 Intrinsic Value of Company $55,678,895,579.82

Shares outstanding assuming dilution 1600000000

Intrinsic Value per share $34.80

Growth RateIntrinsic Values

15.00% $32.0617.22% $34.80

19.00% $37.1420.00% $38.5122.00% $41.38

From the chart above we can conclude that even with the highest predicted growth rate QCOM is OVERVALUED.

b) Two-Stage Dividend Discount Model (Damodaran)The second valuation model was used to evaluate the accuracy of the Owner Earnings model taking into considerations additional factors. First was assign weights to various growth rates estimates.

Growth Rate Weight

Historical Growth = 24.40% 20.00%Outside Estimates = 17.22% 50.00%Fundamental Growth = 14.91% 30.00%

Weighted Average 17.96%

Again I used the average estimated weight for the 1st stage growth rate and then used a growth rate of 8% for the 2nd stage growth rate. I weighted my prediction more so with the average estimated growth rate because I feel that this number is a better representation than the other two. I also weighed the historical growth less because it plays the least role in the future growth rate.

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After inputting these numbers I came up with a value of $20.36 again showing that the stock is overvalued..c.) Technical Analysis

According to the technical analysis chart, it looks as though QCOM has broken through the resistance and might be able to stay above the 300 moving average. However, because it did just cross the line, there is a chance that the stock could go back down below the line.

V. Financial Analysis

The analysis of financial statements covers a 6-year period. Qualcomm has a very strong Income Statement, Balance Sheet and Statement of Cash Flows. All of its margins are very impressive and none of the future risks are related to its financials. Operating, profit and financial health ratios are well above the industry averages and above those predicted by Value Line for the telecommunications equipment industry in the next 5 years.

Balance Sheet. The balance sheet looks very strong and over the past 6 years even improved somewhat. Liabilities are tightly controlled and decreased from 15% in 2001 to 12% in 2006. The most significant change on this statement is the decrease in current assets and an increase in long-term assets. This was caused by shift from investing in short-term marketable securities to longer-term marketable securities. Cash has also decreased 11% of total assets compared to 17% in the previous year due to increased capital expenditures. Still, the Company carries no debt and an increase in total assets comes from operations.

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Income Statement. License and Royalty revenues contributed 37% of total sales in 2006 compared to only 29% in 2001. This is due to the increasing trend towards more interactive phones. Cost of Sales decreased to 29% of total sales from 39% in 2001. Net Profit Margin decreased slightly from the previous year from 38% to 33%.

Cash Flows. Although net change in Cash has been negative $463 million, it should not be any of concern. The negative net cash in 2006 is a result of increased financing activities. Cash flows from operating activities has been steadily increasing and jumped from $1,051 million in 2001 to $3,253 million at the end of 2006 – a 200% increase.

VI. Other Considerations

Management Quality Paul Jacobs, son of the founder of Qualcomm, recently became a new CEO of the Company replacing 73-year old Irwin Jacobs. Experts expect the new CEO to exercise little bit more diplomacy in dealing with competitors and regulatory entities. The shift may be expected since Qualcomm is no longer an underdog of telecommunications equipment industry and its lavish revenues from licensing fees attract a lot scrutiny from regulators.

Although management compensation at Qualcomm may not be the most modest in the corporate world, it is moderate relative to the size and the past performance of the company. Qualcomm also grants options to selected employees, directors and consultants to the Company.

Risks

Lawsuits brought by Broadcom accusing Qualcomm of patent infringement have been dominating the recent headlines. Qualcomm answered by the counter lawsuits. In the latest turn of the events, Qualcomm won an injunction against Broadcom. The federal judge enjoined “Broadcom Corp. (BRCM) from further solicitation, use or dissemination of Qualcomm's confidential Wideband Code Division Multiple Access, or WCDMA, trade secrets. The injunction stays in effect until the trial date in October 2007.

Probe in the European markets into its licensing practices strongly supported by Nokia and other major cell phone makers is Qualcomm’s other concern. This probe is informal and investigative in nature at this time. The purpose of this inquiry is to test the claims of competitors that Qualcomm is engaged in the “unfair” licensing practices. This poses a large risk to QCOM because roughly 87% of total revenues were international revenues.

Possibility that Nokia may not renew its licensing agreement with Qualcomm is another near term threat. Nokia, a handset maker and an important Qualcomm client, may walk away from business during the fourth quarter of 2007. The license contract expires on April 9, 2007 and Nokia may not renew its license agreement. As a result, Qualcomm's results could suffer by 4 to 6 cents in diluted earnings per share. This possibility is unlikely. If Nokia refuses to pay the licensing fees, then it will have to concentrate only on GSM networks and stay away from

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growing CDMA and WCDMA markets. The more likely outcome should be some type of a compromise.UPDATE: Phone News is reporting that Nokia, Qualcomm (NasdaqGS: QCOM) and Sprint (NYSE: S - News) have scheduled a press conference for Wednesday February 22..

The introduction of WiMax is still a threat to Qualcomm’s 3G use. Although there has not been any disruption with QCOM due to WiMax, there still is the risk.

VI. Analyst Recommendation

The investment recommendation for Qualcomm is SELL. Even though there are many optimistic analysts saying to keep a hold of Qualcomm, I feel the company is too risky for our portfolio. Also, my valuations show that the stock is overperforming by a pretty significant amount. Therefore, again, I am recommending a SELL.

Sources

1 “TI sees slower growth, Qualcomm bullish on 3G” Phil Carson http://proxy.mul.missouri.edu:8547/ehost/detail?vid=4&hid=121&sid=90b3c01c-75cd-4f13-9615-35184c1d1381%40sessionmgr1062 “Qualcomm's Net Climbs, Aided by New Cellphones” Don Clark. Wall Street Journal. http://proxy.mul.missouri.edu:2081/pqdlink?Ver=1&Exp=02-19-2012&FMT=7&DID=1201807351&RQT=309The Value LineBusinessWeek.comPC TodayCNNMoney.comFinance.yahoo.comSeekingalpha.com

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Disclaimer: This analysis does not necessarily reflect the beliefs of the University of Missouri-Columbia or the College of Business. The insights and opinions are of the students of Investment Funds Management and should not be used in personal investment decisions. The University of Missouri and the author of this analysis take no responsibility for the validity of the valuation and analysis.

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Exhibit A:

Inputs to the modelCurrent Earnings per share = $1.46

(in currency)

Current Dividends per share = $0.48

(in currency)

Enter length of extraordinary growth period = 5 (in years)

Do you want to enter cost of equity directly? No (Yes or No)

If yes, enter the cost of equity = 14.58% (in percent)

If no, enter the inputs to the cost of equity

Beta of the stock = 2.4

Riskfree rate= 4.98%(in

percent)

Risk Premium= 4.00%(in

percent)

Do you want to use the historical growth rate? yes (Yes or No)If yes, enter EPS from five years ago = $0.49

(in currency)

Do you have an outside estimate of growth ? Yes (Yes or No)

If yes, enter the estimated growth: 17.22% (in percent)

Do you want to calculate the growth rate from fundamentals? Yes

(Yes or No)

If yes, enter the following inputs:Net Income Currently = $2,470.00 Last year

(in currency)

Book Value of Equity = $13,406.00

$11,119.00

(in currency)

Tax Rate on Income= 22.00% (in percent)

The following will be the inputs to the fundamental growth formulation:

ROE = 22.21%(in

percent)

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Retention = 67.12%

(in percent)

Do you want to change any of these inputs for the high growth period? no

(Yes or No)

If yes, specify the values for these inputs (Please enter all variables)

ROE = 22.21%(in

percent)Retention = 67.12%

(in percent)

Do you want to change any of these inputs for the stable growth period? No

(Yes or No)

If yes, specify the values for these inputs

ROE = 22.21%(in

percent)

Specify weights to be assigned to each of these growth rates:Historical Growth Rate = 20.00% (in percent)

Outside Prediction of Growth = 50.00% (in percent)

Fundamental Estimate of Growth = 30.00% (in percent)

Enter growth rate in stable growth period? 8.00% (in percent)

Stable payout ratio from fundamentals is = 63.99% (in percent)Do you want to change this payout ratio? no (Yes or No)If yes, enter the stable payout ratio=   (in percent)

Will the beta to change in the stable period? No (Yes or No)If yes, enter the beta for stable period =  

Before reviewing the output, check to see if any warnings appear on the next page.

Warnings

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Output from the program

Cost of Equity = 14.58%

Current Earnings per share= $1.46

Growth Rate in Earnings per shareGrowth Rate Weight

Historical Growth = 24.40% 20.00%

Outside Estimates = 17.22% 50.00%Fundamental Growth = 14.91% 30.00%

Weighted Average 17.96%

Payout Ratio for high growth phase= 32.88%

The dividends for the high growth phase are shown below (upto 10 years)

1 2 3 4 5 Dividen

ds $0.57 $0.67 $0.79 $0.93 $1.10

Growth Rate in Stable Phase = 8.00%

Payout Ratio in Stable Phase = 63.99%

Cost of Equity in Stable Phase = 14.58%Price at the end of growth phase = $35.03

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Present Value of dividends in high growth phase = $2.62 Present Value of Terminal Price = $17.74 Value of the stock = $20.36

Estimating the value of growthValue of assets in place = $3.29 Value of stable growth = $4.59

Value of extraordinary growth = $12.48

Value of the stock = $20.36

Growth Rate

Extraordinary

Growth period Value

: First phase Growth 0 $7.46 7.96% $5.53 1 $8.40 8.96% $6.12 2 $9.38 9.96% $6.73 3 $10.38

10.96% $7.37 4 $11.41 11.96% $8.02 5 $12.48 12.96% $8.70 6 $13.57 13.96% $9.41 7 $14.70 14.96% $10.14 8 $15.86 15.96% $10.89 9 $17.06 16.96% $11.67 10 $18.29 17.96% $12.48 18.96% $13.31 19.96% $14.17 20.96% $15.06 21.96% $15.98 22.96% $16.93 23.96% $17.91

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