The following was originally published on November 10 and has not been updated or revised.
The teaser ad covered is being circulated again today with a slightly different headline pitch about cellphone royalties, but the balance of the ad (and the teased company) are largely unchanged.
Dr. David Eifrig is touting something that sound interesting today — he’s got a pitch out now for his Retirement Millionaire newsletter over at Stansberry and Associates, and the headline tease is all about profiting from cell phone towers.
The basic spiel is a familiar one for anyone who’s had to dance with these copywriters for a few years — they describe a way that a lot of people are making money from a direct investment, and then tell you how you can do well from a much more indirect (read: lazier) investment that plays off of the same general trend.
The “direct investment” way of making money on this trend toward more need for cell towers is, as you might imagine, leasing your land to a tower-owning company — AT&T (T) or American Tower (AMT) or whoever. But that, of course, means you have to live somewhere that they want to put a tower, and have the zoning approval for a tower, and the desire to live with a 200-foot tower in your backyard.
And the “indirect” way, one would think, would be by buying one of those tower-owning companies, perhaps? That was my initial impression after skimming the first couple paragraphs — and some of those, like sector leader American Tower, have certainly been strong investments for many years (despite the fact that I’ve been uncomfortable with AMT’s valuation for a long time, called it “dang expensive” back in 2010 before they converted to a REIT, and still can’t quite stomach it as a REIT with a 1.4% yield).
But no, my suspicion that Eifrig might be touting one of the tower owners was wrong, as I learned after reading a bit further down the ad. Here’s some of his spiel:
“I’ve found a business that’s created a massive portfolio of over 13,000 patented technologies… Many of which are vital to how mobile phones communicate wirelessly.
“And because of these patents, they essentially collect royalty payments every time:
- A cell tower is built
- Or a mobile phone is sold
“So if you own a phone that can place calls, send text messages or connect to the Internet… this company likely received a royalty for it.
“And if you’ve seen a cell tower built near your home recently, this company likely received a royalty payment for that too….
“And I’m not talking about any phone maker like Apple, Samsung, Nokia or LG, in case you are wondering. And I’m definitely not talking about cell tower builders like American Tower or Crown Castle.”
Ah. So now this spiel starts to sound familiar in a different way — I think Eifrig has spun it before with a different headline and different intro. Here’s a bit more:
“You see, this company owns patents for both the old AND the new wireless technologies.
“And most “smartphones” today are compatible with both…..
“One analyst said that for every iPhone sold, this company makes about $52.50. And based on Apple’s sales in 2013, this royalty company is making an estimated $7.87 billion per year in revenue just from the iPhone.
“And that’s a small fraction of the $24.8 billion it made in total revenue last year.”
So, yes, this is Eifrig trotting out an idea of his that we first saw back in July, when he was calling it the way to get in on the “ground floor” of “America’s Next Great Royalty Business”. This is still, sez the Mighty, Mighty Thinkolator, Qualcomm (QCOM).
And much of what I said back in July about QCOM is still true — it’s a dominant company in wireless technology, with a strong hold on intellectual property backing up both LTE and 3G networks, and with substantial royalty payments from each smartphone sold — along with a large business of actually designing and making the chips for those phones for many of their customers.
Do you want the good news or the bad news? The good news is that the stock is now $10 cheaper than it was when Eifrig teased it back in July at about $80, so it’s looking a bit more reasonably valued now; the bad news is that the stock fell for some substantive reasons, it wasn’t necessarily just a “bad quarter” overreaction that you can gloss over for a “blue chip” type company.
Qualcomm reported last Wednesday evening, and the both missed on the earnings estimates for the quarter and guided down — so their expectations for fourth quarter revenue and earnings are much lower than analysts had been modeling. That brought down everyone’s estimates, and with estimates going down so too fall the shares. So what are the issues?
Well, Qualcomm is still an incredibly strong company, with rising revenue, but there are two significant regulatory issues that are hitting the stock — first is that the US and the EU are apparently sniffing around about antitrust issues, which probably shouldn’t be surprising given QCOM’s market dominance but creates some uncertainty; second, and of more immediate impact on the income statement, is that Chinese regulators have made it difficult for QCOM to collect on the royalties due on their chip designs and technologies from Chinese smartphone makers.
China is the big market for smart phones, and they are using QCOM’s 3G and LTE technologies (among others), so if QCOM is unable to collect their royalties on those technologies in China, much of the growth hopes are dashed. I have no idea how serious this will end up being, but it’s a real concern — right now it seems to come down to “underreporting” with their Chinese chipset design customers not accurately reporting the handset sales on which QCOM should receive royalties, and those per-handset royalties are also substantially lower than QCOM receives for sales in the US and EU.
This has been going on for a few quarters now, though it seems to be coming to a head now with the impact it’s having on forecasts — there’s a pretty good summary of the issue from a Forbes blogger here, but for now it’s really just an uncertain situation — will QCOM be able to collect royalties from Chinese manufacturers? Will the royalty rates be set by contract or by regulators? Will QCOM lose patent protection? We don’t really know.
As of now, with analysts having reduced their forecasts, QCOM trades at 13X next year’s earnings (their quarter started October 1, so we’re already slightly into that year) and 16X trailing earnings — so analysts do still see growth, from $4.40 in the year past to $5.23 in fiscal 2015 and about $5.75 in the year after that. Their estimates might end up being too rosy if China swings further against QCOM, or if there’s a serious US antitrust investigation into their core business — they only cut their long-term earnings estimates by about 25 cents/year for the next two years, which isn’t that much. Investors are more worried about the uncertainty than analysts are, it appears, because you wouldn’t necessarily expect a 5% cut to earnings forecasts to bring a 10%+ drop in the share price.
Today that means we’re essentially paying 13 times earnings for a company growing at about 10% a year, and that grows its dividend by more than that each year (the current yield is about 2.5%). So if you’re not worried about the increased risks they talked about in their earnings report last week, well, the price is right.
Here’s a quote from the Wall Street Journal, to give some perspective:
“Qualcomm has built a lucrative business model in which its chipsets drive the majority of revenues, while licensing of the company’s deep portfolio of wireless patents drives most of the profits. The regulatory inquiries—particularly in China—make it difficult to gauge future profitability of the licensing side as they may result in lower royalty rates once the matters are settled. Meanwhile, Chinese competitors like MediaTek and Spreadtrum are racing to catch up on the chip side.
“Offsetting these challenges for Qualcomm is a low valuation that is now around 9.5 times forward earnings, excluding the company’s $32 billion in cash. Intel ’s ex-cash multiple is around 12.8 times.
“Qualcomm could also elect to increase its capital return in the coming year while it works to resolve its regulatory disputes. The company currently returns about 75% of its free cash flow to shareholders, though its dividend yield of 1.8% is below other large-cap semiconductor peers. About 82% of its cash lies offshore, so Qualcomm may have to consider tapping the debt market if it decides to give back more to shareholders.”
(The 1.8% number would have been the actual trailing yield when the share price was above $80, not the expected yield — they raise the dividend in June each year so half the trailing payment is at last year’s rate. The $32 billion cash number is higher than what you see reflected as “cash” in Yahoo Finance or elsewhere because much of it is in overseas investments — presumably mostly cash-like, similar to Apple or other cash-rich techs.)
And yes, they will continue to get royalties on cell phone handsets and on cell tower equipment — though phones are overwhelmingly the revenue driver that matters. So… interested in Qualcomm now that it’s a bit cheaper? Prefer to invest in those telecoms who own the spectrum (lots of chatter about telcos spinning off their copper/fiber networks as REITs, too, now that Windstream got the green light from the IRS) or the tower companies or someone else? Let us know with a comment below.
Full disclosure: In case I didn’t clarify above, I own shares of Apple and Verizon. I don’t own shares of any of the other companies mentioned, and won’t trade any covered stocks for at least three days.
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