Investors who have had their eye on Qualcomm Inc (NASDAQ: QCOM) are facing quite the dilemma. The smartphone chips behemoth is currently trading at a valuation that makes buying quite attractive. On the other hand, the reason for this is quite troublesome and it’s still unclear how Qualcomm will weather this storm. Let’s trace how the company went from a heady 2016 to a trouble-ridden start of 2017. But first, a brief overview.
Introduction to Qualcomm
The company was founded in 1985 in San Diego, California. The fact that it has become the world’s leading mobile chips supplier is no fluke. The company has established itself as an innovator, building a massive portfolio of wireless technology patents. Its best-known products are the Snapdragon mobile processors and the Snapdragon LTE modems but it is involved in all areas of mobile connectivity. Besides mobile processors and cellular modems, the company also provides Bluetooth products, Wi-Fi solutions and RF products.
Qualcomm went public in December 1991. It currently has a market capitalization of about $83.4 billion. It’s a constituent of the S&P 500 Index and a Fortune 500 company.
The 2016 rise
Qualcomm’s stock hit its 52-week low of $49.67 late in March 2016. However, it was a steady climb from there on after a string of good news. According to S&P Global Market Intelligence, the shares gained an impressive 30% last year. The initial boost came from an announcement that the technology licensing division (QTL), the primary profit generator, was improving its performance. Investors liked this piece of news a lot because QTL took a nasty blow when Chinese smartphone manufacturers refused to pay Qualcomm licensing fees for its 3G and 4G technologies.
The stock jumped again in July, when Qualcomm delivered third-quarter results that comfortably topped Wall Street expectations. Group revenues were 3.6% higher year-on-year at $6.04 billion, which exceeded analyst projections by some $400 million. Revenues at QTL rose by 6%.
Qualcomm’s stock continued its upward march in September, when media reports said the company was negotiating the acquisition of Dutch rival NXP Semiconductors (NASDAQ: NXPI). These rumors proved true, with Qualcomm announcing late in October it had struck a deal worth about $47 billion, debt included.
The NXP deal is very important for Qualcomm. In 2015, the Dutch company became the largest chip supplier to the automotive industry after acquiring Freescale Semiconductor. For Qualcomm, the purchase of NXP means an opportunity to reduce significantly its reliance on the mature smartphone market. This acquisition will give Qualcomm a strong position in vehicle connectivity and advance its push into the Internet of Things (IoT) market.
The 2017 fall
The tide turned on Qualcomm in January, when it found itself under a two-pronged legal attack.
First, the Federal Trade Commission (FTC) went after the company on 17 January, accusing it of monopolistic practices. Three days later, Qualcomm was hit with a lawsuit by one of its top customers – Apple Inc (NASDAQ: AAPL). The iPhone maker has taken aim at Qualcomm for its full-device royalty model and is also looking to claw back $1 billion of rebates and various payments Qualcomm has allegedly withheld. The move was allegedly made to punish Apple for co-operating in an investigation by South Korean antitrust authorities. The inquiry led to a fine of $853 million for Qualcomm.
As can be expected, the market reacted strongly to these developments. Qualcomm’s shares lost more than 18% of their value in January, as calculated by S&P Global Market Intelligence.
Some analysts believe the legal battle between Apple and Qualcomm will drag for at least two years. If Qualcomm loses this battle, its biggest problem won’t be the $1 billion in damages that Apple is seeking. A victory for the iPhone maker could mean a change in Qualcomm’s entire licensing model, which would pummel its bottom line. Apple may also ditch Qualcomm as a supplier as the exclusive contract between the companies expired in 2016.
In addition, Qualcomm’s legal troubles could threaten the NXP deal. According to Pacific Crest analyst Mike McConnell, this is the real risk for Qualcomm.
A more optimistic view
McConnell is not particularly concerned about the potential loss of Apple as a client. In a report released a few days ago, the analyst said this would reduce Qualcomm’s valuation by only $1.
It’s also possible that Apple and Qualcomm settle the dispute, as many expect. In such a scenario, McConnell sees a bigger hit: he estimates an $8 per-share cut for Qualcomm’s technology licensing operations.
News agencies have also noted that Qualcomm may not have to defend itself against the FTC. US President Donald Trump has appointed Maureen K. Ohlhausen as head of the agency. This is important because the FTC commissioner was vehemently opposed to the lawsuit against Qualcomm, which raises the possibility of the case being dropped.
It should be clear by now that potential buyers are facing a tough decision. The company’s legal problems have brought its shares down to about $56, way below the 52-week high of $71.62. Qualcomm is currently trading at a price/earnings ratio of 17.2 against an industry average of 27, according to Morningstar. On a forward basis, the figure slides to 12. The price/book and price/sales ratios for the company are 2.7 and 3.5, respectively, which are quite below both the industry average and Qualcomm’s five-year average values.
Meanwhile, the stock offers a 3.76% yield on an annualized dividend of $2.12 per share. Qualcomm has increased its dividends for 14 years in a row and the payout ratio currently stands at 51.3%.
In strictly valuation terms, this is a good time to buy. Let’s not forget that we’re talking about a market leader here and a company with solid prospects for growth in adjacent markets. The company generates serious cash flows and remains in a robust financial position. But what also remains is the fact that things could go sideways. The lawsuits and a potential collapse of the NXP deal will not topple Qualcomm, but such developments will mean a much longer journey towards the desired growth.
I do not have a financial interest in any of the companies featured in this article, nor do I plan on having one within the next three days.
This article reflects my opinions. The company is not paying me to write it and I do not have any business relationship with any companies mentioned in it.