Despite a bull run in tech stocks during the past five years, Qualcomm (NASDAQ:QCOM) stock has been mostly on the downtrend. During this period, the return has been an average -4%. True, the company still creates cutting-edge technologies, has a global footprint and a massive patent portfolio. But it hasn’t mattered much. For the most part, the litigation risks have been a major overhang on QCOM stock.
This week we got more evidence of this when short-selling firm, Kerrisdale Capital, targeted the company with a brutal report. On the news, Qualcomm stock fell about 5%.
The main takeaway from the report: QCOM stock could plunge a staggering 60%, which would put market cap to under $25 billion.
Why the horrific assessment? Well, Kerrisdale believes that QCOM could lose its antitrust battle with the Federal Trade Commission. This would force the company to license its cellular technologies to rivals, such as Intel (NASDAQ:INTC). Most importantly, the terms would need to be on “fair, reasonable and non-discriminatory.”
Essentially, this would be a major blow to the core business model for QCOM. For several decades, the company has generated billions in high-margin revenues from its extensive patent portfolio, which has allowed for high barriers to entry. Yet any cracks in this could worsen quickly as there would likely be renegotiations of many existing contracts, such as with Apple (NASDAQ:AAPL) and its various partners (Apple is currently in litigation with QCOM regarding fee disputes). Ultimately, it will get tougher and tougher for QCOM to monetize its technologies.
It’s true that predicting the outcome of a complex regulatory case is extremely difficult. It’s not just about the existing law but also political considerations.
But Kerrisdale’s analysis is well argued. It notes that federal judge Lucy Koh has already made several unfavorable rulings for QCOM. The report also provides references to documents that indicate that the company may have been too aggressive with its business practices.
In terms of the financial impact, here’s the analysis from Kerrisdale:
“Even if we assume a far higher ‘fair’ royalty of $1.50 per device — an amount that Apple’s chief operating officer said in sworn testimony that he proposed as relatively fair back in 2007 — we estimate that resetting Qualcomm’s licensing revenue to fair levels will slash revenue by $2.7 billion (relative to fiscal year 2018) and reduce run-rate diluted EPS to $1.64, implying a fair value stock price of ~$21 based on historical Qualcomm and peer multiples — [[61%]] lower than the current price. Even in this scenario, Qualcomm would continue to siphon $2.5 billion per year out of the cellular industry — an amount that few outside of Qualcomm would likely view as unjustly paltry.”
Bottom Line on Qualcomm Stock
QCOM stock still has its bright spots. Keep in mind that the dividend yield is a hefty 4.53%, which is one of the highest among tech companies. QCOM also should benefit from the move towards 5G. The company has definitely been an innovator in this space.
Oh, and Wall Street is still upbeat on QCOM stock, with the price target at $67.60. This implies 30% upside from currently.
However, the FTC case is a big-time wildcard — and the judge is expected to hand down a decision within the next couple weeks (there will also be the announcement of the quarterly numbers during this time period). So given the potential grave consecutive of a negative ruling, it’s probably best to stay clear of QCOM stock for now.
Tom Taulli is the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.