Qualcomm, Inc. (QCOM) Stock Has Problems Beyond Apple Inc. (AAPL)

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The narrative surrounding Qualcomm, Inc. (NASDAQ:QCOM) stock changed in late January, when Apple Inc. (NASDAQ:AAPL) sued the chip maker for $1 billion. Qualcomm’s high-margin fabless model had been a big part of the bull case for QCOM stock. Suddenly, that royalty-based model looked more like that of a “patent troll” than a desirable licensing stream. QCOM stock fell 13% on the news, and has regained only a portion of those losses.

Qualcomm, Inc. (QCOM) Stock Has Problems Beyond Apple Inc. (AAPL)

While the AAPL lawsuit has been the headline news, there are other concerns for Qualcomm shareholders. Competition, regulatory pressure and earnings all present risks at the moment. It’s not as if QCOM stock is pricing in incredible growth, with the stock trading at about 12x 2017 analyst consensus EPS. But Qualcomm may not be pricing in all those risks, either.

AAPL and QCOM Stock

What’s notable about the change in sentiment toward QCOM stock is that the recent concerns, on their own, shouldn’t be that big a deal. The Apple lawsuit is no exception. AAPL is asking for $1 billion in damages, which isn’t a lot of money for Qualcomm. QCOM stock has a market cap of $82 billion; a $1 billion payment would represent about 1.2% of its value, or about less than 70 cents per share.

Meanwhile, Qualcomm ended its first quarter (ending Dec. 25) with over $10 billion in cash and marketable securities on its balance sheet. QCOM quite literally could simply write a check for the $1 billion in damages — even if it loses or settles with Apple.

But the concern is that the Apple lawsuit is just the tip of the iceberg, so to speak. Apple’s contention is that Qualcomm’s pricing itself is unfair. QCOM — per Apple’s interpretation — charges royalties based on the value of the entire device, not just the technology being licensed.

On AAPL’s Q1 earnings call, CEO Tim Cook said the strategy was “somewhat like buying a sofa, and you charge somebody a different price depending upon the price of the house that it goes into.”

Qualcomm naturally has defended its strategy, and it’s too early to tell on whose side U.S. courts will fall. But the questions raised by the Apple lawsuit have implications that go beyond a single court case.

QCOM Stock and Licensing Revenue

The core problem for QCOM stock is that Apple isn’t alone in questioning its model. Qualcomm has been hit with an $800 million-plus fine in South Korea for alleged antitrust violations under a similar theory to that being pushed by AAPL. (That fine is under appeal.) Qualcomm already paid nearly a billion dollars to settle an investigation in China. And a week before the Apple lawsuit, the U.S. FTC announced its own investigation.

The issue isn’t just fines and lawsuits, or a billion dollars here and another billion there. The licensing model is the foundation of Qualcomm’s business. Per the company’s 10-K, the licensing segment generated $6.5 billion in pre-tax earnings. The rest of the company created $2.2 billion in profit — barely one-third of the licensing business’s total.

If QCOM’s royalty rate has to come down, or the base on which those royalties is charged moves from the value of the product to the value of the part, Qualcomm’s profit margins and revenue can come down substantially. Potential changes in the licensing model are a legitimate risk to QCOM stock. And it’s not the only risk out there.

QCOM Stock Has Other Concerns, Too

Even if the licensing model stays largely intact, Qualcomm’s sales and earnings have other sources of pressure. Overall market growth for smartphones, in particular, is stalling out. That’s one reason why AAPL stock — even at all-time highs — still has a relatively modest earnings multiple.

In response, Qualcomm is acquiring NXP Semiconductors NV (NASDAQ:NXPI), which will move the company into automotive and IoT (Internet of Things). But that acquisition also moves Qualcomm into a more traditional manufacturing model — and won’t close until the end of this year, per company guidance. Benefits from the merger will take some time to accrue, and Qualcomm could see integration disruption in 2018.

Finally, there’s competition. Intel Corporation (NASDAQ:INTC) has partially displaced QCOM in some iPhone models, and could take more slots if the legal battle takes time to play out. In automotive, NXP will take on Nvidia Corporation (NASDAQ:NVDA) and Mobileye NV (NYSE:MBLY). That’s a lot of giants taking on a tight market — one reason why NVDA stock has slumped more than 16% over the past few weeks.

Is there enough to short QCOM? Probably not — not unless an investor is willing to aggressively bet on Apple’s interpretation of Qualcomm’s business model. But there’s enough here to justify the recent slump in QCOM stock, and an earnings multiple that looks simply too low. And the problem for Qualcomm is that while the Apple lawsuit is the most covered story, it’s not the only story that can hurt QCOM stock.

As of this writing, Vince Martin had no position in any securities mentioned.

After spending time at a retail brokerage, Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets.


Article printed from InvestorPlace Media, https://investorplace.com/2017/03/qualcomm-inc-qcom-stock-problems/.

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