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China’s Cancelling of 4G Orders Slows Qualcomm’s Revenue Growth
August 12, 2019
Qualcomm reported Q3/F’19 results with revenue of $4.9B slightly and non-GAAP EPS of $0.80 due to better cost controls, mix, and a lower tax rate. Chinese OEM customers have been cancelling 4G smartphone orders ahead of anticipated 5G launches in early C2020 combined with ongoing smartphone macro weakness and non-Qualcomm QCT customer Huawei gaining share in China.
August 12, 2019
Qualcomm reported Q3/F’19 results with revenue of $4.9B slightly and non-GAAP EPS of $0.80 due to better cost controls, mix, and a lower tax rate. Chinese OEM customers have been cancelling 4G smartphone orders ahead of anticipated 5G launches in early C2020 combined with ongoing smartphone macro weakness and non-Qualcomm QCT customer Huawei gaining share in China.
Table 1: Q319 Qualcomm Selected Financials
Source: Company Reports
Although the interim Huawei agreement ended this quarter, a settlement and a new licensing deal with Huawei could serve as a catalyst for future
growth. Qualcomm initiated an appeal for a stay to the Ninth Circuit after Judge Koh denied their motion for a stay of her June 18 ruling as expected. On July 10, the Ninth Circuit granted an expedited appeal with the answering brief due October 4 and the optional reply brief due October 25, but the entirety of the appeal process could still take up to ~1-2 years if escalated to the US Supreme Court. While there is increased uncertainty on Qualcomm’s future royalty rates, ability to collect if customers decide to stop paying during a potential required renegotiation, and scope of potential changes to its global licensing agreements, Qualcomm appears well positioned to benefit with 5G network builds ramping around the world. The recent Apple settlement protects a portion of Qualcomm’s long-term licensing business model, as does increasing smartphone market share with leading Android OEMs as 5G smartphone shipments ramp entering 2020 and beyond. Qualcomm’s outlook for Q4/F’19 was impacted by similar weak trends expected in Q1/F’20. The notion that Huawei is affecting Qualcomm is backed by data from Canalys. Smartphone shipments for Q2 indicate that Huawei is gaining market share in China. The table below of smartphone unit shipments shows how Huawei has gained market share in China at the expense of virtually everyone else. The Chinese market used to be evenly divided, but Huawei has now separated itself from the pack to become the clear number one.
Table 2: Q219 China Smartphone Shipments, Share, Change
growth. Qualcomm initiated an appeal for a stay to the Ninth Circuit after Judge Koh denied their motion for a stay of her June 18 ruling as expected. On July 10, the Ninth Circuit granted an expedited appeal with the answering brief due October 4 and the optional reply brief due October 25, but the entirety of the appeal process could still take up to ~1-2 years if escalated to the US Supreme Court. While there is increased uncertainty on Qualcomm’s future royalty rates, ability to collect if customers decide to stop paying during a potential required renegotiation, and scope of potential changes to its global licensing agreements, Qualcomm appears well positioned to benefit with 5G network builds ramping around the world. The recent Apple settlement protects a portion of Qualcomm’s long-term licensing business model, as does increasing smartphone market share with leading Android OEMs as 5G smartphone shipments ramp entering 2020 and beyond. Qualcomm’s outlook for Q4/F’19 was impacted by similar weak trends expected in Q1/F’20. The notion that Huawei is affecting Qualcomm is backed by data from Canalys. Smartphone shipments for Q2 indicate that Huawei is gaining market share in China. The table below of smartphone unit shipments shows how Huawei has gained market share in China at the expense of virtually everyone else. The Chinese market used to be evenly divided, but Huawei has now separated itself from the pack to become the clear number one.
Table 2: Q219 China Smartphone Shipments, Share, Change
Source: Canalys
However, Huawei is encountering problems outside of China. Growth abroad slowed down considerably and is much lower than that in China. Shipments would have declined if it weren’t for the Chinese market compensating for everywhere else. The table below shows that Huawei's overall shipments grew by just 8%, compared to 31% within China.
Table 3: Q219 Global Smartphone Shipments, Share, Y/Y Change
Table 3: Q219 Global Smartphone Shipments, Share, Y/Y Change
Source: Canalys
In Q119, Huawei was able to increase shipments by over 50%, which would indicate that the decision by the U.S. government to put Huawei on its Entity List in early May had an impact on smartphone shipments. The table below lists the relevant numbers.
Table 4: Q119 Global Smartphone Shipments, Share, Y/Y Change
Table 4: Q119 Global Smartphone Shipments, Share, Y/Y Change
Source: Canalys
Huawei dependency on Qualcomm has been steadily eroding, with its own Kirin line SoCs that compete with Qualcomm’s Snapdragon chipsets. Huawei intends to use Kirin chips on 60% of its smartphones in the second half of 2019, an increase of 15% and 20% compared to the first half of 2019 and the second half of 2018. Huawei had been using Snapdragon chipsets in many of its mid-range and entry-level smartphones but will eventually be replaced by its own chipsets. The sanctions imposed by the U.S. will only give more impetus to these efforts. However, Qualcomm’s prospects could be better longer term. The Chinese market may be the single biggest market for smartphones in terms of unit shipments but represents roughly 30% of the global market. So, even if Huawei dominates China, Qualcomm can still benefit from opportunities that open up elsewhere, especially if Huawei’s non-Chinese sales slow.
Qualcomm’s CEO said in the earnings call, “But I look at the Huawei focus on China a little different; I think it creates an opportunity for our customer base coming out of China companies like Vivo, OPPO, OnePlus, and Xiaomi, outside China especially in Europe that's accretive to us especially in the 5G transition. And we look that opportunity is probably permanent not one-time. I think the interest on the European carriers have been very high.” Qualcomm stands to gain from additional sales if Huawei decides to, or is forced to, retreat. The other Chinese brands tend to use complete chipset solutions from Qualcomm, which offer higher product and licensing revenue. In contrast, a company like Apple prefers to pair its own application processor with a Qualcomm modem chip - an arrangement that yields much less to Qualcomm. If Apple develops its own modem chip as it seems to be planning, then the need for Qualcomm is reduced even further. The outlook for Qualcomm includes the following considerations:
Qualcomm’s CEO said in the earnings call, “But I look at the Huawei focus on China a little different; I think it creates an opportunity for our customer base coming out of China companies like Vivo, OPPO, OnePlus, and Xiaomi, outside China especially in Europe that's accretive to us especially in the 5G transition. And we look that opportunity is probably permanent not one-time. I think the interest on the European carriers have been very high.” Qualcomm stands to gain from additional sales if Huawei decides to, or is forced to, retreat. The other Chinese brands tend to use complete chipset solutions from Qualcomm, which offer higher product and licensing revenue. In contrast, a company like Apple prefers to pair its own application processor with a Qualcomm modem chip - an arrangement that yields much less to Qualcomm. If Apple develops its own modem chip as it seems to be planning, then the need for Qualcomm is reduced even further. The outlook for Qualcomm includes the following considerations:
- First, since Huawei primarily uses its own internally developed basebands and does not pay Qualcomm full royalties with no payments included in Qualcomm’s forward guidance, Huawei’s share gains from Qualcomm QCT customers and full license paying customers will have an adverse impact on Qualcomm.
- Second, due to ongoing smartphone macro weakness, Qualcomm lowered their macro outlook for smartphones by 100M units for C2019.
- Third, with China now committed to 5G, Qualcomm 4G customers in China have cancelled some orders and upcoming 4G smartphone launches to focus on 5G smartphone launches in early C2020.
- Finally, outside of China, customers are also delaying smartphone upgrades consistent with Apple’s declining iPhone sales and in part due to consumers delaying purchases ahead of anticipated 5G smartphones.