In the book How Google Works, Eric Schmidt and Jonathan Rosenberg talk extensively about the convergence of three big trends in business: the Internet, mobile communication, and cloud computing. Semiconductor giant Qualcomm, Inc. (NASDAQ:QCOM) has been one of the biggest beneficiaries of this convergence.
Its chip technology has helped power billions of cellphones since its founding in the mid-1980s. QCOM offers both chips and licenses to its technology that resulted in $23.6 billion in sales last year and $7.4 billion in operating cash flow.
That 31.4% cash flow margin demonstrates that Qualcomm is fantastically profitable. Last year, that totaled $3.81 in reported earnings. For the full current year, analysts project a big jump in earnings to $4.66 per share on sales of $23.8 billion. They expect only a modest bump in sales and profits for fiscal 2018.
The Dangers of Qualcomm
The slow growth in recent years (sales peaked in fiscal 2014 at $26.5 billion) is a key reason that QCOM stock has sagged. Its highest level was a hair above $81 per share in April 2014. However, shares now trade below $53 per share, close to its lows over the past 52 weeks.
The competition also doesn’t appreciate that Qualcomm is so dominant. Its CDMA (Code Division Multiple Access) technology is prevalent in nearly every cell phone the 3G and 4G wireless communication standards. Any cell phone manufacturer that makes these handsets has to pay a royalty to Qualcomm.
This has led to a slew of legal challenges to its patents. Just this week, Blackberry Ltd (NASDAQ:BBRY), an erstwhile giant in the cell phone market, was awarded an $815 million “refund.” A court ruled that Qualcomm owed the refund to Blackberry, suggesting that Blackberry had overpaid on its royalties to Qualcomm because of its flagging sales of Blackberry mobile devices. The decision looks to be binding, and Qualcomm will make the payment out of its large cash reserves.
iPhone juggernaut Apple Inc. (NASDAQ:AAPL) is also fighting with Qualcomm. The dispute involves both of Qualcomm’s businesses — it supplies chips to iPhones, and Apple also pays it royalties. The current spat is said to total $1 billion, or slightly more than the Blackberry settlement.
A quick search of Qualcomm’s other disputes include Samsung Electronics (OTCMKTS:SSNLF) and Chinese firms including Meizu. China went after Qualcomm recently, accusing it of violating antitrust rules because of its chip and patent stronghold on mobile devices. Since then, it has sought to settle and renegotiate patent agreements.
Add it all up, and investing in Qualcomm is not exactly straightforward.
The Bull Case
QCOM stock currently yields close to 4%, though, so there is consolation for patient investors hoping that the company can successfully navigate current and future disputes, and eventually grow steadily again.
A considerable cash hoard also helps protect on the downside. First quarter cash and marketable securities totaled nearly $30 billion. Clearly, it can afford a large number of unfavorable patent dispute results, if it came to that.
Qualcomm also announced last fall the acquisition of NXP Semiconductors NV (NASDAQ:NXPI). The deal totals $38 billion and adds chip exposure to new markets including automotive, the internet of things (IoT), data centers, and networking. The deal could be a game changer for QCOM, whose current market capitalization is only about $75 billion.
The merger has been approved by NXP Semiconductors shareholders and is expected to close by the end of the year. It will put Qualcomm in more direct competition with other chip providers, including Nvidia Corporation (NASDAQ:NVDA) (autonomous driving cars) and Intel Corporation (NASDAQ:INTC) (cell phones and data centers).
Bottom Line on QCOM Stock
The NXP Semiconductors purchase offers the best potential for Qualcomm to boost sales and profit growth. However, it is largely outside of its core mobile phone chip expertise. At worst, it suggests QCOM doesn’t think its current businesses have appealing growth potential going forward.
But at 11.3 times forward earnings estimates and with a dividend yield double that of the overall market, QCOM stock looks like an interesting investment candidate. The low valuation provides downside protection should patent disputes continue to be costly and if the core chip and licensing business fails to grow again.
The NXP Semiconductor purchase adds more potential for growth, though the new businesses are also extremely competitive. But while Qualcomm’s management figures out the new businesses, the existing ones will continue to generate billions in cash flow for many years to come.
As of this writing, Ryan Fuhrmann was long INTC.
