Qualcomm, Inc. (NASDAQ:QCOM) stock looks awfully tempting at the moment. The shares now pay a dividend that yields more than 4%. Analysts still expect 2018 EPS over $4, implying a forward P/E multiple under 14x for QCOM stock.
At a time when fellow tech giants like Alphabet Inc (NASDAQ:GOOGL, NASDAQ:GOOG) and Facebook Inc (NASDAQ:FB) are soaring, the almost-15% decline in QCOM stock year-to-date seems to create a bargain.
That’s simply not the case, however. A licensing battle with Apple Inc. (NASDAQ:AAPL) has garnered the headlines, but there are significant risks to Qualcomm’s business model at the moment. QCOM stock might look cheap, but it’s still pricing in some growth. And there’s a very real risk that Qualcomm profits are set to decline — possibly substantially so.
Potential Impact On Qualcomm Stock
QCOM stock simply hasn’t recovered since tanking on legal concerns in mid-January. The announcement of an investigation by the U.S. Federal Trade Commission started the decline. But it was the announcement of a lawsuit by Apple that sent Qualcomm stock down double-digits to what was then a six-month low.
It might seem easy to dismiss the Apple-related risk. Apple’s suit only claimed $1 billion in damages, at least initially. But Qualcomm stock has a market capitalization of $83 billion. It could easily write a check to Apple for the funds, having ended fiscal Q2 with nearly $29 billion in cash on the balance sheet.
But Apple’s move has to be seen in the context of Qualcomm as a whole. The tech giant’s argument is that Qualcomm is charging royalties not only on its products, but in essence on the entire iPhone. If Apple wins that argument, the impact on Qualcomm won’t be limited to just the iPhone. Its very licensing business model will be at risk.
Given that Qualcomm’s licensing business — what it calls the QTL segment — generates roughly 80% of segment-level profit, that’s creates a huge risk to QCOM stock. And that risk still doesn’t look priced in.
Can Apple Win?
The most obvious question is whether Apple has a legitimate claim in its action against Qualcomm. And from a layman’s perspective, it would appear that is the case.
Qualcomm has responded to Apple’s charges
, to be sure. And not even the best lawyers can be sure how the case will play out. But Qualcomm’s statement sent by email to Barron’s last week had an interesting passage:
“It simply is untrue that Qualcomm is seeking to collect royalties for Apple innovations that have nothing to do with Qualcomm’s technology. Moreover, the per-device royalty Qualcomm charges Apple’s contract manufacturers…is less than what Apple charges for a single wall plug.”
The problem for Qualcomm is that Apple isn’t necessarily arguing that Qualcomm is getting royalties on “Apple innovations”. Apple is arguing that Qualcomm is charging royalties for aspects of the iPhone on which Qualcomm does not have a patent — whether they were “Apple innovations” or not.
Meanwhile, a recent Supreme Court decision involving printer maker Lexmark International Inc (NYSE:LXK) appears to support Apple’s contention, one reason the lawsuit was broadened.
All told, there’s a chance that Apple can win against Qualcomm in court. And, again, that won’t be a matter of just a couple of billion dollars in damages, or lower royalties for iPhones. It will threaten Qualcomm’s licensing business, the segment that that drives around 80% of QCOM profit.
QCOM Stock Has Other Problems, Too
Of course, Apple isn’t Qualcomm’s only problem. Qualcomm already has paid an $865 million antitrust fine in South Korea. It paid nearly $1 billion for similar violations in China. The idea that regulators might back off seems hugely optimistic at this point.
Competition is coming too, with Intel Corporation (NASDAQ:INTC) entering the cellular modem space. And there’s the problem that high-end smartphone growth seems likely to be relatively meager for some time. That fear is, of course, why Apple stock, even at all-time highs, receives a rather light earnings multiple itself.
The acquisition of NXP Semiconductors NV (NASDAQ:NXPI) could help on both fronts, by diversifying Qualcomm’s business into automotive and other spaces. But even that acquisition may not go through, given an extended investigation in Europe.
When you add up the risks, suddenly Qualcomm stock doesn’t look all that attractive. The 4% dividend yield sounds good, but if earnings tank, that dividend may be cut. The 14x earnings multiple similarly seems cheap. But, again, if profits decline, QCOM stock will follow.
The risks facing Qualcomm aren’t overblown at the moment. But they are real and not the result of QCOM stock bears attacking the stock. And they could be enough to send Qualcomm stock tumbling.
As of this writing, Vince Martin has no positions in any securities mentioned.
