Quick Thoughts: Facebook and Qualcomm

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–          Facebook crushed consensus on 53% sales growth, accelerating from 38% in 1Q13, with mobile ads accounting for 41% of total revenues, all in a soft display advertising market.

–          Mea culpa – FB may face big long term strategic challenges from platform OS owners, but the business has huge momentum and near term estimates now look conservative.

–          Qualcomm also beat on sales, which were up 35% YoY, a testament to a still vibrant mobile device market, to the on-going shift to 3g/4G, and to Qualcomm’s competitive share gains.

–          Qualcomm has plenty of runway – its 3G/4G IPR position is strong, 45% of 2012 phones were still 2G only,and  QCT is taking share in device chipsets while addressing more of the BOM.

After a few notable earnings misses in tech over the past few days, Facebook and Qualcomm both delivered impressive results. For Facebook, the quarter showed evidence it’s been able to monetize mobile which now makes up 41% of revenue versus 30% last quarter despite a notable whiff with its Facebook “Home” app for Android phones. Investors greeted the quarter with delight sending shares up as much as 19% in after hours trading. Qualcomm also showed a robust quarter with all around double digit growth in revenues, chip shipments, and reported device sales on which it earns licensing revenue. Further, ASPs of these devices ticked up with increasing smartphone sales versus feature phones. While the news sent shares up 4% in after hours, Qualcomm looks cheap to me, as perhaps the company best positioned to exploit the future of mobile technology.

But first let’s talk about Facebook. We’ve previously written on the company in depth and offered longer term caution on overly optimistic 5 years consensus expectations that expect revenue growth at 30% back in January. These figures have since been revised to a lower and, thus, more achievable 24% CAGR. The company’s remarkable 2Q13 suggests that it is likely to be able to more than keep pace with expectations for a while, pushing our cautious longer term outlook to the back burner.

In the short term it is obvious the company is firing on all cylinders and executing on its mobile strategy well. Even the failure of Facebook “Home” couldn’t hold Zuckerberg & Company back. Perhaps the biggest news was mobile revenues that have been growing faster than desktop and have gone from nearly zero in Q1 2012 to about $742M in Q2 2013. To put this into context, it took Facebook 7 years to hit $731M total revenue threshold in Q1 2011. Facebook has been able to grow its mobile business to that level in 6 quarters. The reported mobile revenue number is nipping at the heels of Google, which generated some $4.6B in mobile ad revenue last year, and puts Facebook as the second largest mobile advertising platform.

Aside from mobile, the company’s international breakouts are telling. User growth in developed markets such as the US/Canada and Europe is decelerating with YoY growth at 6.4% and 10.5% YoY. Asia and rest of the world grew monthly active users by 32.9% and 29.1% YoY respectively. But per user revenues in the emerging markets are lower than in developed markets. A user in the US is worth $4.32 in revenue during the quarter versus a user in Asia who is worth $0.75. The rest of the world ex-US, Europe, and Asia is even lower at $0.63. While user growth may be decelerating in certain areas, Facebook is executing well on monetizing the user base globally. Per user revenue in the US grew 35% YoY and 43% in the rest of the world. The effect is growing international revenue as US/Canada revenue fell 290 basis points from 48.2% to 45.1% of revenue YoY. Asia and the rest of the world now makes up 26.7% of revenue, up from 22.1%. As the company grows users and increases user monetization, the next few quarters are lining up nicely for Facebook. Still, I remain concerned that the current valuation implies long term growth that may be very difficult to achieve, given the threat from Google, Apple , Microsoft, and Amazon, all of which can lever their OS platforms to attack the same revenue opportunities being targeted by Facebook. Moreover, Facebook’s increasingly cluttered newsfeed may eventually lead to flagging user engagement, although there is no evidence of that now.

Onto Qualcomm, which also delivered impressive results coming in at the high end of its guidance and surprising investors. Top line revenue at $6.24B beat expectations of $6.05B and was up 35% YoY while EPS came in on target at $1.03 and was up 21% YoY. Despite investors’ positive after hours response to the earnings release, consensus expectations remain very cautious on Qualcomm, calling for sharp deceleration in both sales and earnings, based on worries over royalty rates and a possible slowdown in the high end smartphone market. Our April 2013 piece, “Qualcomm: Whadda We Gotta Do to Get Some Respect Around Here” (LINK), took major issue with this perspective. The Q213 results may help to calm these fears.

Smartphone sales remain strong. Total reported device sales by Qualcomm licensees were $56.5 billion, above the high end of its prior guidance range. The company estimates that 244 million to 248 million 3G/4G-based devices were shipped by licensees in the March quarter at an average selling price of $227 to $233, a healthy ASP at the high end of the 3 year range. These strong sales resulted in very strong licensing revenues, up 17% YoY. There is also a lot of runway for QTL to continue its growth in the future. Qualcomm continues to add to its industry best portfolio of advanced wireless technologies, and the global transition from 2G, where Qualcomm makes no royalties, to 3G/4G, where they do, is still only a bit more than half way along. With that, the company is increasing guidance for both device sales and ASPs upward for the fiscal year. The expected boom in low-end smartphones will do little to decrease global ASPs as these devices are typically more expensive than the feature phones that they replace.

Qualcomm’s chip business, also known as QCT, is underappreciated. Qualcomm is exposed to the guts of mobile devices as its modem and ARM-based processor designs are best-in-class and it leads in system-on-a-chip integration. Growth in this business won’t cease with expectations around low-end smartphones proliferating, Qualcomm’s Snapdragon 200 will be found in likely the majority of entry level phones coming out this year. Qualcomm’s chipsets are found in a wide range of devices and integration and innovation are allowing it to address an increasing portion of the bill of materials. Its new RF360 Front End Solution takes band fragmentation out of the equation and allows handset makers to produce a single device that is compatible with 40 wireless bands. With a single chip, Qualcomm’s RF customers would be able to make a single model, compatible with almost all carriers, enjoying considerable economies of scale and inventory flexibility. The solution is a win for Qualcomm and can only help grow its MSM chip volumes. Qualcomm also has the unique ability to integrate its RF solution into a system on package with an application processor reducing power draw which is an important KPI for handset makers.

With TI leaving the mobile app processor space and NVIDIA now the only major apps processor designer that is not Apple or Samsung, Qualcomm just picked up more design wins in the tablet space. Google’s new Nexus 7, incidentally just announced today, will feature a Snapdragon S4 processor, which offers high performance at an entry level price point. Qualcomm has some 40 tablet design wins in the pipeline and likely to leverage its high performance Snapdragon 600 and 800.

With the company upping its guidance for the next quarter, we can only reiterate the compelling opportunity offered by Qualcomm. Few companies are as well positioned to reap the spoils of mobile growth.

For our full research notes, please visit our published research site.

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