A Temporarily Out-Of-Favor Chipmaker Presenting An Attractive Opportunity

Summary

• Why Qualcomm's R&D spent is outsized.
• This expense is both optional and underestimated by Wall Street.
• Qualcomm trades at a discount to its historical multiple, while its revenue is of a type that I rate above any other.

You have to give credit where it's due. It was fellow contributor Chris Lau who put Qualcomm (NASDAQ:QCOM) back on my radar early in 2017. Qualcomm's share price has collapsed due to a lawsuit from Apple (AAPL), attention from regulators and the absence of an exciting growth product. Meanwhile, there are important positives, as it gets most of its revenue from licensing royalties, which is a terrific type of revenue. The company doesn't need to do much R&D to sustain its business, but it is investing heavily into R&D. This was originally a founder-operated business and is still chaired by the son of the founder.

R&D is optional

Qualcomm gets ¾ of its revenue from licensing royalties. Every maker of 3G and 4G connected devices out there keeps shipping monies to California. Qualcomm owns this evergreen IP, and it doesn't need to come up with a better version every year like so many of the box builders out there do. Its customers need to build better products and are on a never-stopping treadmill of having to bring out the next best thing. The company just holds its hand up regardless of whether its architecture gets put into the Galaxy 6 or iPhone 8.

R&D underestimated

Qualcomm spends 22% of revenue on R&D. That's in line with the percentage of revenues spent by chip designers like AMD, Nvidia (NVDA), and Intel (INTC). The company is in an enviable position where it could shut down most of its R&D department and its licensing revenue wouldn't be at risk for many years. As a percentage of product revenue, which is on a clock as well, its R&D spent is much higher. R&D investments are often underappreciated by Wall Street, and in my experience, more so in family-run companies and companies that excel at R&D. Which gets me to my third point.

INTC R&D to Revenue (TTM) data by YCharts

Qualcomm is a family-run company

Qualcomm was founded by Irwin M. Jacobs and Andrew Viterbi. Later it was led by Paul E. Jacobs, who is Irwin Jacobs son. Paul Jacobs is a tech guy with 82 patents in wireless technology and devices to his name. He is now chairman of the Board, with Steven Mollenkopf leading the company. Jacobs owns 1.4 million shares, which strongly aligns his interests with those of minority shareholders. Mollenkopf owns 250,000 shares, which is a good amount, but unfortunately, he received in excess of $10 million worth of annual compensation. Ideally, I'd like to see a higher multiple in ownership/salary.

Family-run companies, and especially founder-led companies, tend to perform better. Qualcomm has some of those characteristics. These kinds of companies tend to do well in recessions, which is another reason I like it. This party can't go on forever, right?

Problems at Qualcomm

The company's problems are of the headline-making variety. Tech giant Apple (AAPL) is suing Qualcomm in an aggressive effort to curb the latter's attractive royalty business. This is scaring the market, but with Apple also based in the U.S. and the country's long history of protecting property rights, including tech patents, these fears are overblown.

Then there's the EU carefully reviewing Qualcomm's acquisition of NXP Semiconductors (NXPI). With recent record fines for U.S. tech giants Alphabet (GOOG, GOOGL) and Apple, investors are rightfully worried as to whether the EU will continue to be so aggressive.

Bottom line

Qualcomm is returning 75% of free cash flow to shareholders. Trading at a multiple of free cash flow of just 13x, significantly below its historical multiple, that's an attractive stream of cash towards investors.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.