On Monday, chipmaker Qualcomm, Inc. (NASDAQ:QCOM) got a rather impressive upgrade from J.P. Morgan analyst Rod Hall. It wasn’t just the new “overweight” rating and upped price target of $68 for QCOM stock that turned heads — it was also the commentary.
Indeed, all things considered, Hall’s stance could be considered nothing less than a glowing review. He told investors to not worry about a legal battle with Apple Inc. (NASDAQ:AAPL) that will (one way or another) end up lowering Qualcomm’s revenue, and instead focus on the upside of an impending acquisition with NXP Semiconductors NV (NASDAQ:NXPI).
While the looming merger with NXP has been pretty well covered by this point, Hall’s upgrade begs a deeper look at exactly what NXP Semiconductors brings to the table, and why QCOM stock holders should be so excited.
What is Qualcomm Actually Getting?
Hall’s exact words regarding the $68 price target on QCOM shares:
“We note that this feels conservative to us considering current market sentiment around Intel and what we believe are solid growth prospects for Qualcomm in automotive and IoT oriented applications for their silicon,” adding that there should be “well over 50% earnings accretion due to the NXPI deal and we believe this deal could close as early at CQ3 though Qualcomm has simply said that closure is expected by the end of the year.”
At $68, by the way, Hall’s target is still 15% above the stock’s current price despite the post-upgrade surge.
So what exactly is so great about NXP Semiconductors… a company that some investors have never even heard of, and most investors probably don’t know all that well? As the J.P. Morgan analyst explained, the addition of Netherlands-based NXP brings a treasure trove of automotive and Internet of Things technology to the table.
Now that it’s shed its Standard Products division via a spinoff of a company called Nexparia, NXP is left only with its High Performance Mixed Signal (HPMS) arm. Everything within that arm, though, is a red-hot technology.
Its four primary subdivisions under the HPMS umbrella are secure interface and infrastructure, secure connected devices (at home in the world of the Internet of Things), secure identification solutions (product tagging) and automotive … a divisional moniker that doesn’t do the division justice.
By “automotive,” NXP actually means advanced driver assistance and safety platforms like auto-braking, collision-detection, etc. But this arm also powers in-car infotainment systems. All told, its automotive arm generates more than 40% of the company’s HPMS revenue, and that proportion is about to explode. The ADAS market should be worth $42 billion by 2021, growing at an annualized pace of 10% to get there.
That’s why Rod Hall made the comparison to Intel Corporation (NASDAQ:INTC). Intel recently announced its plans to acquire NXP rival Mobileye NV (NYSE:MBLY), paying a considerable premium that Qualcomm won’t have to pay to acquire NXP Semiconductors. NXPI is presently valued at 19.8 times its trailing twelve-month earnings and 3.8 times its revenue. MBLY, conversely, is valued at 134 times earnings, and 38 times sales.
That said, it’s not as if everything else NXP Semiconductors is doing is holding the company back. In fact, it’s the collective growth of all four of its remaining (after the spinoff of Nexparia) divisions that’s largely been under touted.
The graphic below tells the tale of its recent past and foreseeable future. Thanks to the successful — and now fruitful — 2015 merger with Freescale Semiconductor, NXP is clearly firing on all cylinders.
Click to Enlarge While the historical growth is palpable, the future doesn’t look terribly thrilling. Earnings growth is expected to slow, and revenue is expected to slide.
Don’t latch onto the outlooks too firmly though. NXP has developed a rather strong habit of topping earnings and revenue estimates … something Rod Hall seems to be embracing.
Looking Ahead for QCOM Stock
The melding of NXP and Qualcomm won’t be particularly easy. NXP makes the chips it sells, while Qualcomm outsources all of its manufacturing and instead focuses on licensing its IP (the crux of the legal entanglement between it and Apple right now). The business models might not mesh, at least at first.
NXP also brings a fair amount of debt with it. As of the latest look, NXP owes $6.5 billion in long-term debt that will be added to Qualcomm’s balance sheet when all is said and done. Qualcomm can handle it, but nobody prefers to add to a burden.
Still, between the looming growth of the ADAS market and an Internet of Things hardware/software market that’s expected to be worth $470 billion by 2020, Hall’s upgrade makes a lot of sense. Most investors may be overlooking just how big of a deal the pairing of NXP and Qualcomm is.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.