Best Stocks 2015: Qualcomm Inc.

By Markets Fool.com

This article is part of the series Top Tech Stocks 2015. Click here to read other installments of this series.

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New Year, new stocks.

With many investors rebalancing their portfolios in the transition between last year and this year, fresh investing ideas are always in demand. As a specialist in tech stocks, I recently cast my ballot for my five top tech stocks for 2015 with an accompanying in-depth investment thesis for each name on my list.

And today, I turn my attention to semiconductor giant Qualcomm .

2 beautiful businesses in 1 company
To properly understand Qualcomm's investment merit, one first needs to grasp that Qualcomm's operations really consist of two separate, but related, businesses. For the uninitiated, Qualcomm both makes exceptional mobile processors, a booming market in its own right, but also generates significant profits from licensing its massive troves of tech and telecom patents.

Qualcomm's chipset division, officially known as Qualcomm CDMA Technologies (QCT), designs and sells multiple lines of semiconductors. QCT's bread and butter are baseband modems that handle core mobile functions like data and voice transmission, GPS, and some multimedia applications in mobile devices like tablets and smartphones. Its massively popular Snapdragon line of mobile SoC, short for "system on a chip," also provides advanced application and graphics processing as well. Qualcomm's mobile chips are some of the most popular processors for both smartphone and tablets.

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Financially speaking, QCT is the revenue juggernaut of Qualcomm's operations. Over the past several years, QCT has produced an increasingly large percentage of Qualcomm's overall sales, generating 70% of Qualcomm's total revenue in FY 2014. Its margin profile is nothing to sneeze at either.

FY '14

FY '13

FY '12

QCT Sales

$18.67

$16.72

$12.14

QCT EBT

$3.81

$3.19

$2.29

EBT as % of Sales

20%

19%

19%

Source: Qualcomm IR, all figures in billions $US

In terms of its economics, QCT is clearly a strong business in its own right. And with its long legacy of technological leadership, Qualcomm's chipset business is poised to continue to thrive for years to come.

However, for QCT's massive size, it simply cannot, at least when it comes to profitability, hold a candle to Qualcomm's other significant business segment -- Qualcomm Technology Licensing (QTL). As the name suggests, QTL seeks to monetize Qualcomm's significant portfolio of patents. And thankfully for Qualcomm investors, QTL is an absolute cash cow.

FY '14

FY '13

FY '12

QLT Sales

$7.57

$7.55

$6.33

QLT EBT

$6.59

$6.59

$5.59

EBT as % of Sales

87%

87%

88%

Source: Qualcomm IR, all figures in billions $US

Thanks to its amazingly high margins, QTL produces the bulk of Qualcomm's actual profits. Thanks to the breadth and depth of Qualcomm's patent portfolio, its been able to receive royalty payments for every 3G phone sold in the world and many 4G devices as well. Not a bad gig. However, despite its immense profitability, there's also reason for concern that Qualcomm's golden goose might be cooked.

Under siege, especially in China
Although clearly a boon for Qualcomm and its shareholders, it's easy to imagine Qualcomm's various IP licensees' distaste at paying Qualcomm a percentage of every handset sale. So, it shouldn't come as a huge surprise to find that Qualcomm has recently encountered challenges in collecting royalty payments from several foreign handset OEMs, particularly in China.

In its 2014 10-K report, Qualcomm flatly stated, "[I]n China, certain licensees have disputed or underreported royalties owed to us under their license agreements with us, and certain companies have yet to enter into or delayed entering into license agreements with us for their use of our intellectual property, and such licensees and/or companies may continue to do so in the future."

Qualcomm's mobile chip shipments grew 20% in 2014, and it attributed much of that growth of the overall expansion of the Chinese smartphone market. However, QTL licensing revenue grew less than 1% during FY 2014, which illustrates the underlying problem. Chinese smartphone OEMs simply aren't making good on their licensing obligations to Qualcomm, and it's clearly hindering growth in Qualcomm's most profitable segment. This isn't the only issue Qualcomm's facing in China though.

Qualcomm is also currently under investigation by the China National Development and Reform Commission, China's antitrust watchdog. A settlement is expected soon, but it could come with a forced, drastic restructuring of the royalty rates Qualcomm charges its Chinese smartphone OEMs. And with China accounting for 50% of Qualcomm's revenue's, this creates an understandable cloud of concern over the Qualcomm investment thesis. There's also the added risk that the Chinese ruling may set a precedent for more royalty battles in other international markets for Qualcomm.

Is Qualcomm worth the risk?
In one word, yes.

There are obvious possible detractors. A hugely unfavorable patent ruling in China could fundamentally alter the Qualcomm investment thesis. From a risk management perspective, maybe it's worth waiting until the ruling finally emerges in the months ahead before actually pulling the trigger.

However, Qualcomm absolutely dominates two growing and highly lucrative areas of the most important tech growth market of the past (and likely the next) decade. And with its shares trading hands at just 15 times earnings and sporting a 2.3% dividend, I'm of the mind that there's significant value in Qualcomm for investors in 2015 and beyond.

The article Best Stocks 2015: Qualcomm Inc. originally appeared on Fool.com.

Andrew Tonner has no position in any stocks mentioned. The Motley Fool owns shares of Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.