The bull case for Qualcomm (NASDAQ:QCOM) seems reasonably easy to make. Qualcomm stock provides ownership of one of the world’s largest, and most important, semiconductor companies. And QCOM stock is cheap, at less than 15x FY19 consensus EPS, while providing a solid dividend yield of 4.35%.
Add to that fundamental case the potential for growth from the shift to 5G wireless, and it’s not surprising many investors see Qualcomm stock as a screaming buy. But I’m not one of those investors. I’ve been skeptical toward QCOM stock for a few years now, and nothing of late has changed my opinion.
Qualcomm isn’t a bad company, necessarily and QCOM stock isn’t a short. But this is a stock that has traded sideways for most of this decade, and barring something unforeseen, it’s difficult to see how that changes.
The Battle with Apple
At the moment, the biggest aspect of the bull/bear argument over Qualcomm stock comes down to the company’s ongoing legal battle with Apple (NASDAQ:AAPL). If Qualcomm wins, Apple-related revenues and profits return, boosting earnings, and the company could realize as much as $7 billion in damages and payments of cash currently being withheld. That’s fully 10% of the company’s current market capitalization.
But the importance of a win in the fight with Apple goes beyond sheer numbers. A successful patent defense would validate Qualcomm’s entire operating model. It would fend off regulators arguing that the company’s model potentially violates antitrust rules. It also would keep any other clients from rebelling against Qualcomm’s pricing strategies.
To bears, Apple’s response simply is a sign of what is to come. A loss to Apple might very well end Qualcomm’s business model and significantly undercut its profitability. Operating margins already shrunk from 30% in fiscal 2017 (ending September) to less than 25% in FY18. Without pricing power, those margins fall further.
Short-seller Kerrisdale Capital has argued that, in that scenario, Qualcomm stock could potentially fall to $21. And while that might be overwrought, there’s no doubt that a series of legal losses would send QCOM stock tumbling. Earnings would fall, and the current 15x multiple very well might shrink. Intel (NASDAQ:INTC), the world’s largest chip company, trades at just 12x.
So far, the battle with Apple looks like a draw. But that, in turn, suggests the legal fight could drag on for some time. And while it does, the sheer effect of either a win or a loss means that Qualcomm stock likely will trade sideways until there’s a resolution of some kind.
5G and Qualcomm Growth
The other issue for Qualcomm stock is that even ignoring Apple, it isn’t as if growth has been torrid. Adjusted EPS in fiscal 2012 was $3.71; the figure rose to $4.28 five years later. That’s less than 3% annual growth. All of it, and then some, has come from share repurchases. Total adjusted net income in fiscal 2017 (mostly before the Apple fight) was below the level of fiscal 2012.
The issue is simple: a reliance on the smartphone market is unquestionably not a good thing. We’ve seen that with Apple stock of late. We’ve seen that with Skyworks Solutions (NASDAQ:SWKS), which trades below 2015 highs. Cirrus Logic (NASDAQ:CRUS) is back in line with 2012 highs.
Even disregarding Apple, the status quo isn’t good enough for Qualcomm. Assuming normalized earnings are in the $5 per share range (which still seems aggressive), a sub-12x multiple still seems appropriate because the business isn’t growing. Until that changes, QCOM stock is likely to be dead money.
Can QCOM Stock Rally?
To be fair, it’s possible Qualcomm can start driving growth again. 5G is the most obvious reason why, and bears should remember that Broadcom (NASDAQ:AVGO) was willing to pay $82 per share for QCOM. Broadcom’s long success in M&A suggests it knows what it’s doing and that it saw real value in Qualcomm.
But it remains to be seen whether Qualcomm can take advantage of 5G. A loss in the Apple case or further regulatory pressure would undercut Qualcomm’s ability to profit from the shift. It’s also important to remember that the opportunity still is some time off: Verizon Communications (NYSE:VZ) has said it doesn’t expect material 5G revenue until 2021.
In the meantime, what happens to QCOM stock? The likely answer is: nothing. There’s not much reason to suggest a big move until the Apple case is resolved and the nature and size of the 5G opportunity becomes clear.
That’s at least a few quarters off. Until then, it’s difficult to see what changes the current trajectory of QCOM stock. For some investors, the 4%+ yield might be worth the wait. But it’s hard to believe there isn’t a better opportunity out there at least in 2019.
As of this writing, Vince Martin has no positions in any securities mentioned.
