The bad news continues for Qualcomm, Inc. (NASDAQ:QCOM), as QCOM stock continues to struggle, approaching a 52-week low.
But the decline in QCOM stock simply reflects the bad news facing the company. A contentious patent battle with Apple Inc. (NASDAQ:AAPL) rages on, with no end in sight. The company’s acquisition of NXP Semiconductors NV (NASDAQ:NXPI) now looks as if it won’t close on time.
That’s just the recent headlines. The fact remains that Qualcomm wasn’t exactly healthy before the Apple news hit the stock early this year. Despite a strong 2016, QCOM stock entered 2017 still about 20% below all-time highs. Concerns about quickly decelerating growth in the smartphone market raised questions about Qualcomm’s own ability to grow profits.
It’s a toxic combination of a company facing near-term challenges and long-term questions. It’s why Qualcomm stock trades near a 52-week low – and why it deserves to.
Apple’s Impact On QCOM stock
It increasingly looks like the war between Apple and Qualcomm could drag on for years. Last week, Apple won a small battle, as Qualcomm’s motion to dismiss the lawsuit was denied in a federal court.
One court case aside, however, the royalty dispute creates significant risk for QCOM stock. Simply from a short-term standpoint, it creates an overhang on Qualcomm stock. Note that during Qualcomm’s last major dispute, with then-giant Nokia Oyj (ADR) (NYSE:NOK) in 2007-2008, QCOM stock stayed range-bound.
Long-term, however, there’s real reason for concern. Apple’s anger at Qualcomm opens room for Intel Corporation (NASDAQ:INTC) to gain share in LTE. Other licensees may similar stop paying royalties, with several analysts arguing that Chinese firm Huawei already has done so.
But, more broadly, the dispute centers around Qualcomm’s actual business model, and the way in which it structures royalties. With a number of tech giants already taking Apple’s side, Qualcomm’s model is at clear and significant risk. Given how much profit comes from licensing—in the range of 80% before the recent payment freezes—and at what margin (87% in fiscal Q2, again before the freezes), a wider royalty reduction would result in a significant reduction in Qualcomm earnings and a similarly significant reduction in Qualcomm stock.
The NXP Deal May Be In Trouble
In part due to its challenges with mobile, Qualcomm decided to acquire NXP Semiconductors last year. As Charles Payne wrote at the time, the deal made a lot of sense for both parties. For Qualcomm, NXP would diversify its revenue streams away from mobile, most notably into the fast-growing automotive space. Qualcomm stock rose on the news, and kept rising until the deal was officially announced. Investors liked the deal, and still like the automotive opportunity, as seen in the explosive rise of Nvidia Corporation (NASDAQ:NVDA) stock over the past few years.
But the deal may be in trouble. NXP shareholders are looking for a higher bid, with NXPI now trading above the original $110 offer price. Qualcomm’s tender offer, through June, had attracted less than 8% of NXP shareholders.
And now regulators are taking a closer look. European Union regulators have paused the acquisition once again, saying they are still waiting for additional materials. At the least, that pause means that the close of the deal looks highly unlikely to hit Qualcomm’s target of the end of 2017. That, in turn, allows for more movement in the competitive, quickly-changing automotive space – without Qualcomm. While Intel is integrating its acquisition of Mobileye, Qualcomm still will be sitting out.
Meanwhile, if the deal does go through, Qualcomm likely has to pony up a little more, even without the cash from Apple and potentially other suppliers coming in. If the deal falls through, Qualcomm has to pay a $2 billion penalty in most cases, and QCOM stock will tumble. Many investors left with a growth-challenged, lawsuit-facing, smartphone technology business may decide to simply cut their losses.
QCOM Stock Isn’t Cheap Enough
There are real risks here. And yet the reward for taking those risks doesn’t look all that promising. Near $50, QCOM stock trades at about 12x FY17 analyst estimates. That’s pretty much the same multiple as Intel stock. Even assuming a deal with Apple comes and NXPI closes, QCOM’s EPS maybe gets over $5 per share. That in turn could get the stock toward $65-$70, at a similar or slightly higher multiple.
That’s a nice gain, something like 30-40%. But it also likely takes 2-3 years to get there. And if Apple winds up winning in court, and/or the NXP acquisition falls through, the downside is likely similar, if not worse.
Buying QCOM stock now basically is an argument that the issues here are short-term headwinds, and that Qualcomm will come out relatively unscathed on the other side. It’s possible but it’s not likely. And it surely isn’t likely enough to put money behind, at least not yet.
As of this writing, Vince Martin has no positions in any securities mentioned.