Apple & Qualcomm– Rare agreement

For once, Apple and Qualcomm are on the same page.

• Amongst a difficult set of results, there are signs of a number of trends that put the company in a good long-term position, and for once, Apple appears to agree that Qualcomm is on the right track.
• Smartphones, and Android devices in particular are having a difficult time as their biggest market, China, stubbornly refuses to recover and iOS is eating away at its market share from the high end.
• The result has been that Qualcomm’s Android customers are still working down their inventories of chipsets which in turn has led to the disappointing guidance that Qualcomm gave when it reported its FQ3 23 results last week.
• This combined with a very tepid recovery in China’s economy means that the smartphone market will continue to be weak which in turn has forced Qualcomm to reduce its expectations for calendar Q3 and sound cautious for Q4 2023.
• However, there are green shoots elsewhere.
  • First, AI where Apple’s recent moves appear to indicate that it thinks that running generative AI on devices rather than in the cloud is the way to go.
  • On its conference call last week, Apple admitted that AI is “fundamental technologies that are integral to virtually every product that we build” and it is recruiting heavily.
  • Many of Apple’s job descriptions refer to AI, LLMs and inference engines running on devices as opposed to the cloud which is where they run today.
  • RFM research has concluded (see here) that running AI and generative AI in particular offers far greater benefits to the service provider than running them in the cloud.
  • Qualcomm has also long been of this opinion and demonstrated a 1bn image generation model running on its latest silicon at MWC 2023.
  • Furthermore, Qualcomm has also formed a collaboration with Meta platforms that will aim to optimise Meta’s LlaMa foundation models for Qualcomm silicon.
  • This is important because Meta’s LlaMa models have become the development platform of choice for the open-source community and there are already hundreds of free models available that can be used for a wide range of tasks.
  • It is the availability of these models that I suspect is going to put real pressure on generative AI pricing and undermine the business models of so many over-capitalised start-ups.
  • Qualcomm has a head start in implementing LLMs on smartphones and should be able to use this head start to fend off competition as well as maintain pricing.
  • Second, Automotive which has seen a slowdown in revenue growth but not in terms of design wins for digital cockpit and ADAS for 2025 and beyond.
  • Most of the revenues being reported today are from modems being used for telematics and it is this segment that will determine where short-term revenues end up.
  • However, it is in 2025 and beyond when the design wins that have been announced over the last 18 months will start generating revenues and contributing to the financial performance of the company more broadly.
  • Third, modems where I think that Apple is still struggling to produce a commercially viable 5G modem.
  • Apple’s requirement for 5G is what caused it to settle its lawsuit with Qualcomm some time ago and ever since it has been trying to internally replicate Qualcomm’s product.
  • This remains a significant revenue stream for Qualcomm and the market has long expected that Apple will soon be in a position to design Qualcomm out of its devices entirely.
  • The problem is that modems are very difficult to get right and the complexity of the 5G system particularly when it comes to radio frequencies continues to cause Apple problems.
  • Hence, I think that this revenue stream is going to continue for longer than anyone expects adding upside to estimates as well as a cushion should iOS continue to erode Android.
• The net result is that Qualcomm is in a much better position for the long-term than the short-term outlook seems to indicate when taking a quick glance.
• This is one of the reasons why the shares are trading on 14.5x 2023 and 13.2x 2024 which is substantially below much of its peer group.
• This combined with the fact that no one seems to be willing to look past short-term weakness in smartphones creates an opportunity.
• I missed it the last time the shares went to $108, I will be watching more carefully for the next month or so.