Having already built up a thumping market share in mobile baseband chips, maybe some think that Qualcomm's (Nasdaq:QCOM) growth prospects have to be shrinking as the law of large numbers takes hold. That looks like a hasty (not to mention wrong) analysis - not only is Qualcomm continuing to leverage its current market strength, but the company is looking to expand into new markets that should add billions to its addressable market opportunity.

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A Strong Start to the Fiscal Year
Qualcomm reported that sales rose nearly 40% this quarter (and nearly 14% relative to the fiscal fourth quarter), beating the average analyst guess by more than $100 million. Both of the core businesses were strong - licensing saw revenue rise more than 36%, while the chip business had a gaudy 46% topline growth. MSM chip shipment rose 23% from the fourth quarter, and while the number of royalty-earning devices was a little shy of expectation, the average selling prices (ASP) have been stronger than forecasted.

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Qualcomm is trading off margins for growth. Gross margin slid a point sequentially and more than six points from the prior year - not only due to a larger contribution from chips, but lower margins here as well. Good corporate expense control recouped some of this, but operating income rose 24% on a year-over-year basis and operating margin did contract - about three points from the third quarter and four points from last year. Keep in mind, though, that 20%-plus operating income growth is hardly "bad."

No Dip in Chips
With Qualcomm supplying the MSM chip for the Apple's (Nasdaq:AAPL) iPhone 4S, it's perhaps not surprising to see a big sequential boost in results as Broadcom (Nasdaq:BRCM) saw a similar phenomenon. (For related reading, see Steve Jobs And The Apple Story.)

This could be an interesting year for this chip business. The company's share in WCDMA isn't what its old share in CDMA was, but it's moving in the right direction. What's more, Texas Instruments (Nasdaq:TXN) has had enough of the wireless baseband business, and is exiting - and it looks like Qualcomm is picking up that Nokia (NYSE:NOK) business. That would leave Qualcomm in good shape with both Apple and Nokia - arguably the two most interest North American smartphone growth stories in 2012.

That's not all Qualcomm has up its sleeves, though. The company is making a bigger push into application processors and connectivity - opening a new front against Texas Instruments and Broadcom, and certainly challenging Nvidia (Nasdaq:NVDA), Intel (Nasdaq:INTC), and Marvel (Nasdaq:MRVL) as well.


In fact, Qualcomm has big plans to penetrate the PC and tablet market with ARM-based processors for notebooks and tablets. It's a bold move, but the lower power consumption profile of Qualcomm's chips could make it a strong player in those segments where customers are willing to sacrifice absolute high-end performance for longer battery life.

Licensing Still on Plan
Although Qualcomm was perhaps a bit shy on licensed devices this quarter, I'd argue that has far more to do with the overall market growth than anything specific to Qualcomm. What's interesting to me, though, is that the company is seeing pretty solid ASP growth here - even though a lot of growth is coming from emerging markets, where handset prices are typically lower.

The Bottom Line
I love the Qualcomm business model and I don't think rivals like Texas Instruments, Broadcom or Intel are especially eager to see the company spreading out and addressing more markets. That said, the shares are not what you might call overlooked - a trailing EV/EBITDA of over 14 and a trailing EV/revenue of 6 highlight that.

Interestingly, though, the cash flow picture is more encouraging. Giving the company the assumption of high single-digit compound free cash flow growth over the next decade (at a rate slightly below that of Broadcom) suggests a fair value in the mid-$70's. I'd normally like a bigger discount to fair value before buying in, but for a company of Qualcomm's quality it may be worth considering making an exception. (For related reading, see Free Cash Flow: Free, But Not Always Easy.)

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.