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Wed, September 30 at 4:00PM ET

5G Is Good for Qualcomm Stock, But Watch Out for Regulatory Risk

Unresolved issues with the FTC could devastate Qualcomm's licensing business

With 5G right around the corner, Qualcomm (NASDAQ:QCOM) stock has been a name to watch. Investors have already started to bid up shares, with the stock reaching its 52-week high earlier this month. Thanks to an earnings beat and strong guidance for the fiscal first quarter, investors are confident the company has upside potential.

Qualcomm Stock
Source: photobyphm / Shutterstock.com

But at the current share price, is QCOM stock a screaming buy? Growth has been a challenge for Qualcomm these past few years. The company generated $26.5 billion in revenue in the fiscal year ending September 2014. Sales fell as low as $22.3 billion in FY17, but have since rebounded to $24.3 billion for FY19.

The company also has unresolved regulatory risks from the recent Federal Trade Commission decision. Qualcomm appealed the ruling, leaving the destiny of its licensing business in the hands of the United States Court of Appeals for the Ninth Circuit. A ruling in the FTC’s favor could devastate Qualcomm’s lucrative licensing business.

Qualcomm Stock Beats on Earnings

On Nov. 6, QCOM released results for the year ending Sept. 30, 2019. For the fourth quarter, Qualcomm beat on earnings, reporting adjusted earnings per share of 78 cents, versus consensus of 71 cents. This earnings beat was thanks in part to the company’s licensing segment. Licensing revenue went up due to the company winning its legal dispute with Apple (NASDAQ:AAPL), as well as a new royalty agreement with Huawei.

Total revenue for Q4 was $4.8 billion, in line with guidance. Looking to the next quarter, Qualcomm’s guidance calls for similar revenue between $4.4 billion and $5.2 billion, as well as projected earnings between 80 cents and 90 cents a share.

Analysts Mixed on 5G Catalyst for QCOM Stock

Current results are not the whole story with Qualcomm stock. The key catalyst for the company is the rollout of 5G anticipated to start in 2020. JPMorgan analyst Samik Chatterjee projects Qualcomm’s 5G revenue will accelerate starting next year. Chatterjee estimates 5G chip shipments to be 200 million in 2020, rising to 450 million by 2021. Given the complexities of 5G, these new chips will likely sell at higher prices than 4G chips.

But not everyone is bullish on Qualcomm stock. Morgan Stanley’s James Faucette recently downgraded the company. He does not dispute the growth opportunities in 5G, but he believes this catalyst is already priced into shares. Faucette believes there is a chance 5G does not win over the public as quickly as anticipated. 5G may be faster than 4G, but it comes at the cost of uneven performance and shorter battery life.

If the switch over to 5G is slower than estimated, Qualcomm stock may not see a big boost in 2020. In addition, there are concerns of the viability of Qualcomm’s cash cow, its QTL licensing business. Qualcomm makes mobile chips, but earns most of its money charging royalties to manufacturers who utilize its chips in their phones.

The FTC has gone after Qualcomm for anti-competitive practices, particularly the company’s “no license, no chips” policy. A federal court ruled in favor of the FTC, but Qualcomm has won a reprieve, allowing it to repeal the decision.

Luckily for Qualcomm, the company has the Department of Justice, Department of Defense and the Department of Energy on its side. These other federal agencies believe the FTC’s ruling could impact America’s national security and technological advantages. Hearings for the appeal begin in February, with a ruling expected later in 2020.

Risks Impact Valuation

The possible destruction of QTL could devastate Qualcomm’s profitability. But despite these risks, QCOM stock does not exactly trade at a bargain-basement valuation. Qualcomm’s forward price-to-earnings ratio is 29 and its trailing enterprise value/EBITDA ratio is 10.7.

This makes Qualcomm stock cheaper than peers like Broadcom (NASDAQ:AVGO). Broadcom trades at 56.3 times forward earnings and has an EV/EBITDA ratio of 15.5. But Qualcomm trades at higher multiples than Intel (NASDAQ:INTC), which trades at 13.5 times forward earnings and has an EV/EBITDA ratio of 8.5.

What does this mean? Qualcomm stock could see significant multiple expansion if it wins the case. But predicting the outcome of a court decision does not make the best rationale for a buy. In this scenario, it may be best to stay on the sidelines.

Bottom Line: Don’t Rush into QCOM Stock

Qualcomm stock could win big with 5G. But don’t rush out and buy shares today. Until the regulatory threat to the licensing business is resolved, the fate of the company’s cash cow is in the Ninth Circuit’s court (no pun intended).

The revenue growth effects of 5G may take some time. Analysts anticipate the 5G-driven revenue boost will not happen until FY2021. Consensus calls for $22 billion in FY20 revenue, with $27 billion the following year.

What does this mean? Take your time, and tread carefully, with QCOM stock.

As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2019/11/5g-qualcomm-stock-regulatory-risk/.

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