If you believe in the contrarian arguments for “buying when there’s blood in the streets” and the like, Qualcomm, Inc. (NASDAQ:QCOM) is a stock for you. QCOM stock has tanked over the past few months amid a torrent of bad news. The most well-covered dent to the bull case for Qualcomm stock is a royalty dispute with Apple Inc. (NASDAQ:AAPL), but there are other concerns as well.
The change in sentiment has pushed QCOM stock down 15% since the beginning of the year.
That weakness is amplified by the fact that other large-cap tech stocks, including AAPL, Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) and Facebook Inc (NASDAQ:FB), have been on torrid runs so far this year. AAPL stock is up 32% year-to-date, for instance, adding insult to injury for Qualcomm stock.
There is a case for buying the stock at the lows. QCOM stock now yields over 4%. Earnings multiples suggest barely zero growth going forward. Regulatory and legal issues could be resolved in Qualcomm’s favor — at least not move against the company en masse.
However, I’m not buying that case … at least not yet. There are three key risks facing QCOM stock at the moment. And if all three converge, which isn’t likely, but is possible, the impact could be severe. And even with Qualcomm stock looking “cheap,” it’s not cheap enough to take on all of these risks.
The QCOM-AAPL Dispute
The most covered challenge for Qualcomm is its royalty dispute with Apple. AAPL ramped up that fight by directing suppliers, including well-known contract manufacturer Foxconn, to cease royalty payments to QCOM. That development led the company to pull down its Q3 guidance, and sent the stock down about 4%.
The issue is larger for Qualcomm stock than just the money owed. Q3 guidance, for instance, was only pulled down by about $0.5 billion dollars, while QCOM has a market cap of over $80 billion. And one would think at some point that the dispute will be resolved; for all its bluster, Apple still needs Qualcomm products for the iPhone and AAPL remains perilously dependent on that product for growth.
The longer-term concern is whether Apple will minimize, or outright displace, QCOM’s positioning in the iPhone. Intel Corporation (NASDAQ:INTC) has positioned itself as a potential replacement supplier for cellular modems. Qualcomm reportedly generates $12 for each iPhone modem, meaning billions of dollars of high-margin annual revenue are at risk.
And that’s not revenue the company can just replace. The iPhone has roughly 18% market share globally. The proportion of high-dollar phones (as opposed to lower-end models from Chinese manufacturers) is much higher. QCOM already has extensive penetration into Android manufacturers — there’s nowhere else to go. A loss or elimination of Apple revenue comes right off its bottom line. And it significantly impacts the forward-looking valuation of Qualcomm stock.
QCOM Stock: The NXPI Acquisition May Not Close
While the AAPL-QCOM debate has made news, it’s not as if concerns are new to the company’s stock. QCOM stock hasn’t moved for basically five years now, after peaking in early 2014. The primary driver of the weakness in the stock has been a sense that Qualcomm’s best days are behind it. Its revenues come predominantly from the wireless business, and with growth slowing and ‘commoditization’ on the horizon, those revenues will be stagnant at best.
So QCOM decided to acquire NXP Semiconductors NV (NASDAQ:NXPI) in an effort to diversify away from wireless. NXP most notably has a solid presence in automotive, where Mobileye NV (NYSE:MBLY), recently acquired by Intel, and Nvidia Corporation (NASDAQ:NVDA) are projecting substantial growth opportunities.
But that deal may not go through — E.U. antitrust regulators will decide on its clearance by June 9. With regulatory issues already swirling around Qualcomm, including fines in China and Korea and FTC charges in the U.S., clearance is not guaranteed. And if that merger is blocked, Qualcomm stock probably has further to fall.
Qualcomm’s Business Model May Not Hold
Both risks speak toward the overarching problem here: QCOM’s business model simply may not hold up under closer scrutiny. Apple is throwing its weight around. BlackBerry Ltd (NASDAQ:BBRY) just won $800 million-plus (admittedly in a different type of case). Regulators already have taken a closer look, and it’s difficult to imagine them backing off.
The attractiveness of Qualcomm’s largely royalty-based revenue is that it converts to profit at huge margins. That’s a wonderful thing when that revenue is growing, since each incremental win adds almost pure profit.
The problem is when growth stops — the lost revenues come off the bottom line just as fast. That’s why Qualcomm stock stalled out even before the bad-news 2017. It’s why the stock trades at such a low earnings multiple. And it’s why QCOM stock isn’t cheap enough. If revenues decline, profit goes with it.
It’s unlikely that Qualcomm will be hit by an Apple loss, a block of the NXP merger, and additional regulatory and/or customer issues in the next few months. But it’s far from impossible. That combination would suggest substantial downside in QCOM stock — possibly down the low 30s, assuming a 10 to 12x price-to-earnings multiple on lowered earnings-per-share expectations around $3.
The fact that such a worst-case scenario is possible shows the biggest problem with Qualcomm stock: there’s just too many risks. And while some might be priced in right now, it seems clear that all of them are not.
As of this writing, Vince Martin has no positions in any securities mentioned.