Now that a month has passed since Qualcomm (NASDAQ:QCOM) plunged on the combo lawsuits from the FTC and Apple (NASDAQ:AAPL), one needs to review the situation. As well, Qualcomm reported quarterly earnings and took analyst questions regarding the lawsuits.
The stock is down significantly from the heights related to the NXP Semi (NASDAQ:NXPI) merger prior to the Apple lawsuit. Despite a small bounce to nearly $57, does owning Qualcomm offer substantial value at this level?
Over Reaction To Earnings
After reporting FQ1 results that were generally inline with expectations, analysts couldn't lower price targets fast enough. Qualcomm earned $1.19 per share and provided guidance inline with the Q2 estimates of $1.20. Typically, large earnings per share for a stock trading in the $50s.
Now with the stock re-rated lower, the stock only trades at about 11.8x forward estimates. As well, the merger with NXP Semi provides enormous upside potential to EPS estimates with the synergies and the general concept that Qualcomm got the semiconductor company on the cheap at only $110 per share in cash.
My previous research suggested a simple calculation would bring the pro-forma EPS target to over $6 per share prior to the $500 million synergy estimates. With fewer than 1.5 billion shares outstanding, the synergies would add another $0.33 to the EPS total within a couple of years.
So without a top customer like Apple suing the company, the valuation would exist without question. Qualcomm appeared cheap even trading above $65 prior to the lawsuits, but the market probably knew the Apple lawsuit was on the way.
Clearly, the risk exists that Qualcomm could lose some business with Apple. The risks are multi-pronged.
Qualcomm could lose modem chip sales to Apple that are already partly transitioning to Intel (NASDAQ:INTC) as a second source. This risk was existed for a couple of years, but the profits don't come from the QCT division.
The bigger issue is the licensing or QTL division where FQ1 EBT of $1.5 billion more than doubles the QCT group.
The recent NDRC agreement seems to back up the Qualcomm claims that the lawsuit is bogus. Analyst Timothy Arcuri of Cowen & Company had the following statement on the FQ1 earnings call:
I guess, my question, Derek, is really what does Apple want? Because if you look at the effective rate that they are paying, they pay basically on-cause and they pay the contract -- and the contract manufacturer pays you. If you do some math, they are sort in the low to mid-200 basis points as a percentage of COGS, which doesn't seem to be that much different than what the 4G rate that you signed in China is. So, what do they want other than just getting a better deal?
Qualcomm provided the following slide on the rectification plan with the NDRC.
More interesting is that Apple filed a lawsuit against Qualcomm in China alleging a violation of China's Anti-Monopoly Law. The EVP though suggested that Apple refused the deal accepted by Chinese firms.
Apple was offered terms consistent with terms accepted by more than one hundred other Chinese companies and refused to even consider them. These terms were consistent with our NDRC Rectification plan.
The main difference being that Apple sells smartphones costing in excess of $600 while many of the Chinese phones sell for less than $200. Even with the rate caps, the impact to Apple is larger, but the patent royalty market has always worked in this manner.
The key investor takeaway is that if the Chinese government and smartphone OEMs are coming to agreements with Qualcomm than the risk with Apple is over stated. Qualcomm has the best modems and controls the wireless patents that are unavoidable by Apple.
The case that the most profitable smartphone OEM is somehow harmed seems to still contradict the facts. The NXP Semi deal cushions a lot of the blow from possibly losing the sole moden slot in the upcoming iPhones. Use any weakness to buy Qualcomm.
Disclosure: I am/we are long QCOM, AAPL.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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