Qualcomm Vs. Broadcom: How To Trade The Upcoming Shareholder Meeting

Summary

• Qualcomm's side of the story has the most potential upside and downside.
• Broadcom's side of the story has less near-term risk, but far bigger long-term implications for this M&A juggernaut.
• How I plan to trade before and after the March 6th meeting.

Qualcomm Inc. (NASDAQ:QCOM) and Broadcom Limited (NASDAQ:AVGO) have been sparring on and off since Broadcom's initial offer to buy Qualcomm last November, 2017 for $60 a share in cash plus $10 a share in Broadcom stock. Since then, both companies have been aggressive in their approaches, with a crucial turning point coming to the saga on Qualcomm's March 6, 2018, shareholder meeting. I think there should be plenty of potential volatility around next week's meeting as final maneuvers and propositions are disclosed before the shareholder meeting potentially changes the rules of the game. I like the potential predictability of the upcoming meeting, and its potential effects, and have recently made an oversized bet on the expected results potentially following soon after the meeting concludes.

First, let's take a quick look at Qualcomm's situation. Qualcomm's stance from the beginning has been that Broadcom's bids significantly undervalue the company, there are licensing concerns, and the fact that there is significant regulatory risk for a deal this big in the space. Every bid since the first continues to exacerbate Qualcomm's management, since it is confident it can deliver more value to its shareholders in the coming years than investors can receive in accepting a quick short-term gain now.

Qualcomm is a well-known technology company with many great products and services along with key customers including Apple Inc. (AAPL). However, management has not been able to deliver much value to shareholders as the company has gone pretty much nowhere over the past 5 years, while Broadcom has soared like a rocket during the same time period.

QCOM data by YCharts

There are many reasons for this, including Qualcomm's ongoing fight with Apple, which still hasn't been resolved, and other underperformance compared to the rest of the sector as it can't find the growth and traction other companies have capitalized on.

Qualcomm latest attempt to create shareholder value is the most recent acquisition offer for NXP Semiconductors (NXPI), which was approved by both company's boards. Qualcomm has been steadfastly trying to acquire NXPI for $110 a share since it first started pursuing the company in late 2016. NXPI shareholders steadfastly held out, saying that Qualcomm also undervalued its company substantially with activist investors such as Elliot Advisors saying a much more realistic bid for NXPI would be in the $135 a share amount, an over 20% premium to what Qualcomm believed was necessary to get the deal done. With Qualcomm's shareholder meeting right around the corner, Qualcomm had no choice but to put up or shut up, and so made a $127.50 per share offer in cash, which got pretty much everyone on board, and lowered the minimum tender threshold to 70% from 80% pretty much guaranteeing NXPI shareholder approval.

Now, why the desperation move by Qualcomm? After the deal, Qualcomm could immediately reaffirm its FY19 EPS guidance of $6.75-$7.50. This deal not only makes Qualcomm a potentially bigger pill for Broadcom to swallow, it also helps emphasize Qualcomm's belief in its being highly undervalued as Qualcomm's forward EPS guidance gives the company a forward P/E of 8.7 - 9.6 based on Wednesday's closing price of $65 per Qualcomm share. Compare this to other deals in the space, which feature forward P/E multiples of around 20 not being uncommon.

Qualcomm's management is confident that it can deliver these earnings after the NXPI acquisition, and can deliver substantial shareholder value next year when these notable earnings will result in a rerating of the company by the market where an expanding P/E valuation will deliver to shareholders the gains they have been waiting years for. Qualcomm also believes that this acquisition increases the value of the company as a whole, therefore emphasizing their belief that Broadcom's bids are significantly undervaluing the company and re-enforcing their argument to shareholders to vote against Broadcom's offers unless the value of those offers get substantially increased.

Now, for Broadcom's argument. This company has performed marvelously for its shareholders over the past 5 years, as seen by the previous chart, including blockbuster deals like in early 2016, when Avago acquired Broadcom, keeping Avago's ticker but Broadcom's name. It is a company known for heavy M&A activity and has been largely successful with its pursuits in the past. Now it has its eyes firmly on Qualcomm and its assets, which it also perceives as valuable for longterm Broadcom shareholder value.

Its main argument is that it is giving Qualcomm shareholders a great offer not only in its initial $70 offer, but especially after it raised the offer to $82 a share, then back down to $79 a share in cash and stock after the NXPI deal was finalized. Broadcom's pursuit of Qualcomm was regardless of whether it could acquire NXPI for $110 a share. When Qualcomm capitulated and gave NXPI shareholders the giant premium they desired, Broadcom saw this as a waste of money and shareholder value destruction, which led the company to reduce its bid from the then-current $82 a share to the new bid of $79 a share consisting of $57 in cash and $22 in stock.

The animosity and positioning between the two companies has risen to new levels since then with claims that Qualcomm is merely participating in "engagement theatre" in its talks instead of constructively trying to reach an agreement. Qualcomm insists it is trying to talk about price, but the two sides are so far apart that little headway can be made on that front at least for now.

For its part, Broadcom is taking the steps it needs to get into position for a deal, taking care of many of the other lingering issues besides the price sticking point. For example, one should possibly assume that Broadcom is the entity involved meeting with CFIUS regarding a potential deal. The assumption here would be that it is communicating with Broadcom outlining some of the regulatory concerns and issues before things go any farther. CFIUS has the power to stop merger activity with a swipe of its pen, if it deems it relevant to national security, but has not acted as of yet besides a meeting or two for clarification. With Broadcom being a Singapore-based company, and Qualcomm a U.S. company, this is just one of many regulatory issues facing a deal that could take around 18 months to complete. Broadcom is so confident it can successfully navigate the regulatory waters that it has put up an $8 billion dollar breakup pledge that Qualcomm shareholders would receive if the deal fell through due to regulatory concerns.

Broadcom is sticking to its guns in its belief that its offer of $79 a share is more than a fair deal for shareholders. Taking a look back at Qualcomm's performance over the last 5 years, its hard to argue against that thesis, especially when Qualcomm's management continues to act suspiciously, including its recent overbid for NXPI. With Broadcom seeming to hold an advantage in talks thus far in swaying shareholder votes, the influential proxy adviser Institutional Shareholder Services (ISS) has entered the fray, reiterating support for 4 of the 6 dissident board nominees that Broadcom has put up for shareholder vote this coming March 6th. If Broadcom gets 4 of the nominees in, it won't be enough for a majority, but it will go a long ways towards getting the two sides to talk more meaningfully about a deal that both can claim victory with.

With the shareholder meeting right around the corner, here are the latest releases by the two companies on Thursday morning giving one final push for each company's agenda on board member votes: Qualcomm's letter; Broadcom's letter.

Here's how I plan to trade around the meeting coming up next week. I bought an oversized position in Qualcomm stock because it looks highly possible that 4-6 of Qualcomm's board members will be replaced next week at the company's shareholder meeting. I believe Broadcom will do well in the vote because sentiment has seemed to shift more towards Broadcom side, including the highly influential advice from ISS. I think that the probability of at least 4 Broadcom members being voted in is very high with a decent shot at getting 5-6 members in. With a new board set up, I don't think it will take long for both sides to come to the bargaining table again with the idea of a compromise soon to follow.

Qualcomm now seems to be focusing on a bid from Broadcom of at least $90 a share. This is approximately 14% higher than Broadcom's current offer of $79 and a tasty 36% premium to where Qualcomm's stock is now trading at around $66 a share. After the meeting is complete, I think it will be highly likely that Broadcom will up its offer again even though it has said its current offer is its "best and final" offer. I always take these types of sayings with a heavy grain of salt as the situation is always evolving.

Compromise, I believe, is right around the corner, and I think Qualcomm shareholders have a potential great gain coming in a short time period if things progress towards the conclusion I see coming. If Qualcomm shareholders fend off the board nominees, I believe Qualcomm shares will initially fall, but don't expect a big drop as Broadcom might still decide to make an offer closer to the $90 deal that would officially tempt Qualcomm. Even if the deal crashes and burns and falls apart, I am fine with turning my Qualcomm investment into a longer core position for me as I also believe that the market is truly undervaluing the company's assets. If things go the way I am forecasting, Broadcom will win 4-6 board seats, and the two sides will re-engage in much more productive talks with the result being a potential offer of at least $85-$90 a share in the not-too-distant future.

If that happens, I will be more than willing to cut down my oversize position dramatically and take my profits to be redeployed in other areas, leaving a smaller position left to play out. I believe a deal is coming soon, one way or another, and even if regulators ultimately kill it, an $8 billion breakup fee will make for a nice special dividend for Qualcomm shareholders, or a nice consolation prize for overspending on NXPI. Best of luck to all.

Analyst’s Disclosure: I am/we are long QCOM. 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.

Comments

[Jacob444]

Of all the articles I've read before about this battle. This one is the best.
http://bit.ly/2G2BLf8

[mmkkgg]

That sounds a little harsh.

[crafool01]

Wow! Wow! Is most of what I can say! Talk about a completely dastardly move, QCOM management in my opinion shows that it has been completely disingenuous in their negotiations with Broadcom. I base this on the fact that they hide from shareholders there forward action of trying to sabotage the deal with a premature government review of the merger to try and derail or run Broadcom off. In my opinion, I believe Mgmt and BOD are only interested in protecting their overly generous salaries and unwarranted fees. I sure as heck hope that the lawyers are salivating at carving these people up, and if merger doesn’t go, I believe shareholders should replace entire board and clean out mgmt.

[User 47798689]

Guy at work, that's what I'm seeing as well.

The more people learn about the details of Hock Tan's offer, the less they like it.

[Guy at Work reading SA]

I don't see the vote getting 6, or even 4, board members. I disagree that things are shifting in favour of broadcom, everything I have been seeing in the past couple of days suggests qcom is getting the edge with large shareholders and improving the light they're portrayed in.

[Downtown10]

Trent, let's say your scenario plays out and an agreement is eventually reached, what happens to NXP? Does Hock accept it at $127.50 or will the agreement require QCOM to walk away (and pay $2B break-up fee)?

[Trent Welsh]

Hock said he was fine buying QCOM with or without NXP so I don't see why he would want to mess with it now that the deal is done. The value has already been destroyed according to Broadcom which is one of the reasons they dropped their offer price for QCOM from $82 to $79. Easier to move on and leave that issue alone and focus exclusively on getting the QCOM deal done. Once he has QCOM he could always sell off NXP Semi or Spin it off to shareholders if he really likes QCOM better as a stand alone entity.

[AUMmmmmm....mmm..mm.nnnn]

I have all of 200 shares. I have been barraged with mail from QCOM and AVGO (probably 70% QCOM) and phone calls, all from QCOM. I have a huge stack on my desk of ballots and voting instruction forms. I told the first guy that called that I would vote for the company that bugged me the least. QCOM sure didn't listen. What a waste of their resources.

[Trent Welsh]

Yes, quite a paper trail here from both of them also. At least they don't have my phone number :). Can't wait for the meeting because the implications will be huge. Best of luck and nothing wrong with having 200 shares at all :). Very nice position by my reckoning.

[User 10177311]

I'm long QCOM, but the stock has been abysmal over the past 5 years. It's flat over that time, while many other tech companies are up 150% to 250% during the same period. The dividend is great, but isn't enough to make up for that.

I don't have a lot of faith in management, as their promises never seem to materialize. The NXPI deal will close soon, but the market doesn't seem to value that very much. I'm not as hopeful as some people that AAPL will settle soon, though I do believe that QCOM is in the right and will prevail eventually.

However, AVGO is basically Valeant. Over-valued and focused on short-term gains. I think its facade will fall apart at some point. I voted for QCOM's board picks. If it looks like AVGO will succeed in the takeover, I'll try to cash out near the deal price rather than get stuck with AVGO stock.

[desirman]

What weighs down Qualcomm's valuation is the period litigation concerning the licensing unit. Although they have legal precedent on their side, I personally think they have to find a balance because constant litigation is hurting shareholder value. The other issue was Qualcomm made the same mistake that Intel made with the PC market, they didn't diversify into new markets earlier. Despite those problems I think Qualcomm's management is doing a great job. The QCT unit is executing flawlessly and NXP is the gateway for the kind of diversification and innovation that is making Intel a hot stock now.

[desirman]

periodic*

[User 10177311]

So many people are mischaracterizing the increase in the bid for NXPI.

On one hand you had people saying that QCOM didn't care about closing the deal (or was trying to scam people) before they raised the bid, but there was no point in raising the bid until near the point where it was clear it would pass the regulatory approvals. Since the market seems sure this deal will close, raising the bid just boosts NXPI to near the offer price and gives people the argument for another raise. Better to wait for the right time.

On the other hand, you have people saying that QCOM only raised the bid to try and fend off Broadcomm. That may have had something to do with the *timing* of the new bid, but it had become pretty clear that the deal would never close at $110. On the other hand, QCOM wasn't so desperate that they gave in and offered the $135 that Elliot was looking for.

It's pretty clear to me that QCOM wanted to ensure the deal closed (because they see the value in NXPI), but not at any cost. Especially given the looming takeover bid, the board has to make sure the deal makes sense for shareholders.

[User 47798689]

The problem with this article is it uses the same weak argument Hock Tan uses when explaining why Qualcomm management needs to change. Namely the lack of share price appreciation the last several years.

And the reason why that reasoning is weak is because it's based on the share price, not the companies fundamentals. It fails to consider that Qualcomm shares were over-valued by investors in the years leading up to the period of underperformance and it lays blame for Apples tortuous interference and meddling with foreign regulators that resulted in questionable fines at the feet of Qualcomm's management when, in fact, this was largely out of their control. They cannot prevent Apple from presenting false testimony or forcing their suppliers to break contracts with Qualcomm. Apple is a bully, you can't negotiate with them because it's their way or the highway. The only way to deal with such outrageous behavior is through legal means. Fortunately, Qualcomm has the experience as well as the resources to defend their intellectual property rights, they have been doing so successfully for over 20 years. But yes, court dockets have waiting lists and Apple has the ability to slow down the process. But that ability is not without it's limits and, in the end, Qualcomm's business model will be upheld, once again.

[User 47798689]

The bottom line is the regulatory concerns are rapidly ballooning. The risk to QCOM shareholders of accepting a deal with such a man as Hock Tan in this climate are great enough to make supporting such a move foolhardy. I say that because, even if a deal is accepted for a higher price than the previous best offer, QCOM shares would be locked into a trading range due to the risk of the deal dragging on forever before collapsing. In the interim, the value of the company would be getting trashed and the share price would gradually follow as it became apparent the deal was a failed enterprise.

Qualcomm would be left in shambles.

[Gandalfthemage]

My few proxy votes went to QCOM.

[desirman]

Financial Times article (paywall):

Broadcom’s $142bn hostile takeover bid for Qualcomm is raising data protection concerns among European lawmakers as they fear the Singapore-based chipmaker could gain control of sensitive EU citizen data.

Qualcomm recently secured a $44bn agreement to buy NXP, a Dutch group that makes chips for German passports, and European officials are uncomfortable with Broadcom having access to such information. 

“We are concerned about the possibility of a European company handling sensitive data of EU citizens falling in the hands of a company that is based in Singapore, where data protection standards are lower than in the EU,” Josef Weidenholzer, vice-president of the S&D, the second-largest party in the European Parliament, told the Financial Times.

This comes days after US lawmakers urged the Trump administration to open an investigation into Broadcom’s bid as they argued that it would be “deeply concerning” if a foreign company took control of a US group through a proxy fight without first gaining the approval of the Committee on Foreign Investment in the US.

Broadcom said earlier this week that its takeover of Qualcomm, which would be the largest tech deal ever, should not be scrutinised by Cfius as “Broadcom is committed to reincorporating from Singapore to the US, and expects to receive the required approvals to do so by the end of Broadcom’s fiscal second quarter.”

A person close to Broadcom said the chipmaker is ready to work closely with European authorities to protect the data and privacy of EU citizens. 

Political pressure against Broadcom’s bid on both sides of the Atlantic comes ahead of a critical Qualcomm shareholder meeting on March 6, when investors of the San Diego-based company will vote on a slate of six out of 11 directors nominated by the Singapore-based group.

Broadcom’s potential takeover of NXP also has a number of German politicians on edge about the future of NXP’s plant in Hamburg, given the Singaporean company’s reputation for aggressive cost-cutting, including laying off workers and stripping research and development. 

Niels Annen, a Social Democrat member of parliament from Hamburg, said: “Qualcomm made a range of assurances regarding the plant in Hamburg that were very positive. There were no such signals from Broadcom and that has raised concerns.”

Although the vote is likely to be very close, several stockbrokers buying and selling shares on behalf of large investors said the tide is shifting in favour of Qualcomm’s management, which is opposed to Broadcom’s board changes and existing takeover proposal. 

Parnassus Endeavor Fund, a top-30 investor in Qualcomm, said it would vote in favour of the current board and against the slate of six out of 11 directors proposed by Broadcom. 

“The current Qualcomm board is committed to getting a higher price or staying independent, and we agree that Qualcomm’s stock is worth much more,” said Jerome Dodson, Parnassus portfolio manager.

Several Qualcomm shareholders are concerned that if Broadcom’s nominees take control of its board they could force the company to agree to a deal that is not in the best interest of investors. 

While the public vow of support by a major shareholder is a strong vote of confidence for Qualcomm’s management, other investors are more open to voting in some of Broadcom’s nominees to bring new points of view to the board.

Earlier this week Qualcomm said it was open to engage further with Broadcom on a higher price than its current “best and final offer” of $79 per share, valuing the company at $142bn, including $25bn in net debt. 

[mmkkgg]

I wonder how many Apple shares the proposed Broadcom directors own?
they could get in there an just really muck up Qcom's lawsuit with Apple.

[vkvraju]

Broadcom’s pursuit of Qualcomm sparks unease in Europe
http://on.ft.com/2t4VxnG

"Although the vote is likely to be very close, several stockbrokers buying and selling shares on behalf of large investors said the tide is shifting in favour of Qualcomm’s management, which is opposed to Broadcom’s board changes and existing takeover proposal."

[desirman]

Europe is strongly against Broadcom buying Qualcomm because of Qualcomm's purchase of NXP. Plus broker's are starting to see the voting tide shift in Qualcomm's favor:

http://bit.ly/2t9BVi1

[chuckster59]

This has been wild and wooly for the past several months. I’d just like to make a few bucks now. Anyone in? ;)

[snoper]

https://seekingalpha.c...

[bulldozer123]

Won’t the top management from both the companies get an indication by now which way the needle is moving ..Or it can be a last minute surprise ...

[us44ever]

Agree with author, QCOM is a better bet...