Last year saw a wave of consolidations in the semiconductor industry, and on Thursday, sources revealed that Dutch chipmaker NXP Semiconductors NV (NASDAQ:NXPI) may sell itself to Qualcomm, Inc. (NASDAQ:QCOM).
The deal values NXPI at $30 billion, and caused both QCOM stock and NXPI stock to jump; QCOM 6.3% and NXPI stock 16.88%.
Usually, when a merger occurs, the stock of the acquiring company goes down, but in this case QCOM stock went up. This signals that the market thinks Qualcomm made the right move. NXPI excels at making devices and components for driverless cars and the connected car market, which Strategy& analysts project will grow at a 29% CAGR to reach €113 billion in 2020.
The smartphone industry is maturing, dragging down sales growth and margins for most phone makers. By purchasing NXPI, QCOM will grow faster, especially in the market for IoT devices such as connected cars.
Qualcomm Stock Pro No. 1: Multiple Growth Drivers
Qualcomm will benefit as multiple emerging technologies increase the demand for its devices and components. These include drones, robotics, wearables, driverless cars, the Internet of Things, virtual reality, cloud computing and 5G.
Qualcomm holds the leading position in 5G technology, with the strongest patent portfolio of any company. Qualcomm CEO Steven Mollenkopf sees 5G rolling out around 2018/2019. In addition to being a source of growth on its own, 5G will power IoT devices such as connected cars and digital medicine.
Qualcomm recently rolled out a new strategy for IoT. QCOM normally produced chips in large batches for smartphone makers, which left out smaller players. Smartphones have fast product cycles, so Qualcomm chips would be produced for a short period of time and then replaced by newer models.
This prevented makers of devices with longer product cycles from using QCOM chips. Now, Arrow Electronics, Inc. (NYSE:ARW) will distribute Qualcomm Snapdragon 410E and 600E chips through 2025. Device makers can order as few as 100 at a time, so even startups can use QCOM chips.
Apple Inc. (NASDAQ:AAPL) recently chose Intel Corporation (NASDAQ:INTC) modems for the iPhone 7, a market long dominated by QCOM. But Qualcomm will also fight Intel on its home turf, entering the Intel-dominated market for data center server chips. Demand will increase as firms build infrastructure to keep up with the explosion of big data.
Qualcomm Stock Pro No. 2: Reasonable QCOM Valuation
Qualcomm trades at 14 times forward earnings, not bad when you consider that acquiring NXPI will boost QCOM’s growth. According to Finviz, NXPI’s earnings will grow at a 27% CAGR for the next five years, faster than the projected growth rate for Qualcomm alone. Last year, UBS removed QCOM from its list of Quality Growth at a Reasonable Price stocks, but things look better now.
Qualcomm Stock Pro No. 3: Good Dividend Yield
Qualcomm also boasts a dividend yield of 3.1%, above the average of 1.91% for the technology sector, as well as the 1.6% yield on a 10-year Treasury bond.
Qualcomm Stock Con No. 1: Slowing Smartphone Sales
The smartphone market has cooled off in recent years. According to Gartner, the growth of smartphone sales slowed from 14.4% in 2015 to only 7% in 2016. Major markets reached their saturation points, including China last year, where smartphone sales fell. Growth will occur mainly in developing countries, where price-sensitive consumers will buy mostly low-end phones.
Most Qualcomm chips are used in smartphones, so with weaker phone sales, QCOM will have to find other sources of growth.
Qualcomm Stock Con No. 2: Pressure on Margins
Smartphones are becoming commoditized, with margins sinking, and only Apple and Samsung earn profits. As a result, manufacturers will try harder to cut costs, denting QCOM’s margins.
Regulators are pushing for lower IP licensing fees, which comprise 91.5% of Qualcomm’s operating profits. Last year, Qualcomm faced antitrust probes from regulators in China, South Korea, Taiwan and the European Union. Qualcomm filed a complaint in June against phone maker Meizu, which underreported smartphone sales to pay lower licensing fees, even after QCOM’s agreement with the Chinese government to charge less.
Qualcomm Stock Con No. 3: Tougher Competition
Qualcomm faces growing competition on two fronts: from chipmakers such as Mediatek Inc. (OTCMKTS:MDTKF) and Intel, and from smartphone makers themselves, which may produce their own chips to cut costs.
Device makers now seek greater competition from chipmakers in order to lower prices. The iPhone 7 includes Intel modems as well QCOM ones. Taiwanese chipmaker Mediatek also may catch up with QCOM’s chips, putting further pressure on QCOM’s margins.
Phone makers also produce more chips on their own, including Apple, Samsung (OTCMKTS:SSNLF) and Xiaomi. This helps them cut costs, but might mean lower profits for QCOM.
The Verdict
I owned QCOM stock for a few years, but sold in May at $55.13. Since QCOM stock now trades in the high $60’s, I sold too soon.
Although Qualcomm faces some challenges to its existing businesses, it will make up for this with new, fast-growing markets. PricewaterhouseCoopers projects that the global market for drones, $2 billion in 2016, will balloon to $127 billion in 2020. Virtual reality, the Internet of Things, 5G, wearables and cloud computing are all expected to grow quickly, and this company is positioned to capitalize on all of them.
At 14 times forward earnings, QCOM stock isn’t too expensive. Buy it to take advantage of the growth of new technologies.
As of writing, Lucas Hahn did not hold a position in any of the aforementioned securities.
