The stock market is again moving broadly higher after a long weekend, but one of the biggest winners after the extended break is chip-maker Qualcomm, Inc. (NASDAQ:QCOM).
Qualcomm stock is up nearly 4% after a big upgrade from research firm Nomura.
Analysts at Nomura believe the takeover attempt from Broadcom Ltd (NASDAQ:AVGO), which has shot shares materially higher recently, is “a gun to the head” for Qualcomm management.
Nomura believes that Qualcomm management has often been “unassertive and complacent.” But the Broadcom offer has QCOM shareholders asking for more. So if Qualcomm wants to remain a standalone franchise, Nomura reasons that Qualcomm will be forced to be more committed to driving shareholder value.
Committed To Driving QCOM Stock Higher
That isn’t a bad thing for Qualcomm stock. It’s why Nomura lifted its price target on Qualcomm stock from $58 all the way to $75.
Does this upgrade make sense? Well, you tell me. Qualcomm just released a letter to shareholders wherein they promised huge profits in 2019 if shareholders agreed to block the Broadcom deal.
Nomura was spot on. Regardless if an acquisition materializes or not, Qualcomm stock will be better off than before the takeover offer because management is now committed to driving the stock price higher.
So does it make sense to buy Qualcomm stock at these levels? I think so. Here’s why:
Broadcom will very likely acquire Qualcomm, but not at a huge premium.
Broadcom Chief Executive Officer Hock Tan has dramatically altered the $300 billion chip industry over the past two years through three huge acquisitions. Given that Broadcom has acted as an industry consolidator under his leadership, Broadcom will likely continue to aggressively push its takeover attempt of Qualcomm.
In other words, this is not a flippant takeover offer. It’s an offer with serious meat on its bones that fits in perfectly with Broadcom’s bigger game plan.
But there won’t be much more meat on the bones than is already there. Tan has changed the entire chip industry landscape over the past several years through acquisitions, but he did so without ever paying more than 7% above his original offer.
QCOM Stock Is Undervalued
It’s unlikely Tan breaks that trend with Qualcomm. But it is likely that Broadcom ups the offer to $75 (a 7% premium). I think there is an 80% chance this happens.
Meanwhile, there is a 20% chance that Qualcomm stock drops back to a standalone fair value. Previously, I thought that fair value was $52. But with an energized management team committed to driving shareholder value, Qualcomm’s standalone value is now higher.
In its recent letter to shareholders, management promised profits of at least $6.75 per share in 2019 — far above Street estimates. Qualcomm’s forward earnings multiple has historically hovered around 13. Because that $6.75 seems like a reach, it’s unlikely Qualcomm gets that 13 multiple. Let’s call it 10. A 10-times multiple on $6.75 earnings implies a one-year forward price target of $67.50, which discounted back by 10%, implies a present value of $61.
In total, there is an 80% chance Qualcomm gets taken out at $75, and a 20% chance it heads to $61. Put those together, and you get a fair value on Qualcomm stock of just over $72.
Bottom Line on QCOM Stock
Given management’s new focus on driving shareholder value, I feel very comfortable owning QCOM stock under $72. That fair value assumes the market gives Qualcomm stock a discounted valuation in a year. The market might give it a premium valuation, in which case QCOM stock is worth a lot more than $72.
Either way, Qualcomm stock is a buy here and now. Either the stock gets taken out at a premium, or management delivers on robust earnings growth and this stock tracks higher anyways.
As of this writing, Luke Lango was long QCOM.