Shares of global chip giant Qualcomm (NASDAQ:QCOM) have been on a wild roller coaster ride over the past few weeks. First, there was the big and unexpected Apple (NASDAQ:AAPL) settlement, which ended several years of costly disputes between the two companies and was broadly a Qualcomm victory. Investors rallied around that good news, and Qualcomm stock soared from under $60, to all time highs of right around $90.
Then, China trade war tensions escalated. That’s bad news for Qualcomm, which has a ton of exposure to the China mobile market. QCOM stock naturally retreated off all time highs as the trade war re-escalated.
Most recently, the FTC has ruled that Qualcomm’s controversial patent-licensing practices violate antitrust law and is ordering the company to renegotiate those licensing deals on fairer terms. In other words, that means Qualcomm is being ordered to renegotiate its licensing deals on less favorable terms for Qualcomm, which implies less licensing revenue for the company. That’s a big deal, too, since a majority of this company’s profits come from the licensing business.
Qualcomm stock was hit hard on that news. It now trades below $70. Thus, over the course of three weeks, QCOM stock has gone from unstoppable juggernaut making new all time highs, to a headwind-plagued stock that has retreated 25% in a few weeks.
What’s next? This stock won’t return to $90 anytime soon. The trade and FTC headwinds are simply too big. But, under $70, the stock does seem undervalued, even in light of those headwinds. As such, while I think things will get worse before they get better, I also think QCOM stock will ultimately rebound from this sell-off.
Qualcomm Stock Won’t Return to $90 Anytime Soon
Broadly speaking, Qualcomm stock was supported at $90 prices so long as everything went right for the company. But, everything isn’t going right, nor will everything go right anytime soon. As such, Qualcomm stock won’t rally back to $90 anytime soon, either.
First, trade war tensions re-escalated in mid-May. That’s bad news for Qualcomm. For the past several years, upwards of 50% of Qualcomm’s revenues have come from China. Last year, China accounted for 67% of Qualcomm’s total revenues.
Further, in the company’s important licensing segment, a significant portion of revenues come from a limited number of licenses, and a majority of those licenses are from China. The licensing business is the profit driver here. Thus, China accounts for nearly 70% of Qualcomm’s total revenues, and likely closer towards 80% of its total profits.
Because of the company’s broad exposure to China, so long as U.S. and China trade tensions continue to escalate, QCOM stock will remain weak.
Second, the FTC came through with a harsh ruling on Qualcomm, broadly saying that the company’s patent-licensing practices violate antitrust law and that the company needs to renegotiate those licenses. That, too, is a big deal. Qualcomm’s licensing business accounts for only 20-35% of total revenues. But, it’s a 70-80% margin business, whereas the rest of Qualcomm is a 10-20% margin business, so roughly 50-75% of Qualcomm’s profits come from the licensing business.
The FTC ruling puts that licensing business at risk of lower revenue and profit potential over the long run. As such, this is a long-running risk which will keep QCOM stock weaker for longer.
All in all, the headwinds facing Qualcomm stock are simply too significant to warrant the stock running back to $90 anytime soon.
The Stock Could Rebound to $80
While a $90 price tag seem unattainable for QCOM stock anytime soon, a rebound back to $80 seems much more likely.
The math here isn’t too hard to follow. There are two risks here. First, trade war risks. Second, lower licensing revenue risks. The first set of risks will pass with time, because the U.S. and China both want to get a deal done before serious damage is inflicted. The second set of risks, however, will last, because licensing contracts will be negotiated lower, and those lower contracts will be in place for the next several years.
Zooming out, global semiconductor sales should move about 1-2% higher per year over the next several years. Given the 5G boom, renewed Apple revenue, and continued urbanization in developing economies, Qualcomm should be able to gain share in that global semi market for the foreseeable future, as those tailwinds offset headwinds related to less favorable licensing contracts. The most likely outcome for Qualcomm going forward is low to mid single revenue growth.
Meanwhile, margins should move higher thanks to renewed Apple revenue. But, they will likely remain below previous peak levels, given the less favorable licensing contracts.
Still, steady low to mid single revenue growth on top of gradual margin expansion should power EPS towards $7 by fiscal 2025. Based on a semiconductor average 16-forward multiple, that implies a reasonable fiscal 2024 price target for QCOM stock of nearly $112. Discounted back by 6.5% per year (three and a half points below 10% to account for the yield), that equates to a fiscal 2019 price target of just over $80.
Bottom Line on Qualcomm Stock
In early May, it looked like nothing could stop QCOM stock. Then, two things did stop the stock, the trade war and a negative FTC ruling. These two risks will ultimately prevent Qualcomm stock from rallying back to its all time high levels any time soon.
But, they won’t keep Qualcomm stock below $70 for long. In the big picture, even considering these risks, this stock is undervalued here. A rally back towards $80 in 2019 is fundamentally supported.
As of this writing, Luke Lango was long QCOM and APPL.