The 3 Musketeers: Broadcom, Qualcomm And NXP Semiconductors

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Includes: AAPL, AVGO, FDN, IYW, NXPI, QCOM, QQQ, SMH, SOXX, XLK
by: The Fortune Teller
Summary

It has been a long, wild, saga involving the "three musketeers" from the semiconductors industry.

Since October 2016, and for almost two years, Qualcomm wanted to buy NXP. It didn't work out.

Since November 2017, and for four months, Broadcom attempted to buy Qualcomm. It didn't work out either.

Now that the trio is done trying to buy each other, it's just about time to revisit each company on a standalone basis.

One clear winner, one clear loser, and one clear un-compelling risk/reward play. But who's the most interesting going forward?

The Three Musketeers

Image result for the three musketeers all for one and one for all

"Unus pro omnibus, omnes pro uno" is a Latin phrase that means "One for all, all for one" in English. This phrase (in French) was made famous by its use in the historical-adventure novel "Les Trois Mousquetaires" (aka "The Three Musketeers") written in 1844 by French author Alexandre Dumas.

In this article, the three musketeers are Broadcom (AVGO), Qualcomm (QCOM), and NXP Semiconductors NV (NXPI).

There's no better way to describe their interest in each other, as well as their endless attempts to form an alliance, than the "all for one and one for all" phrase.

Indeed, should the buyout offers of both QCOM to NXPI, and then AVGO to QCOM, bear fruit - we would have now been referring to this trio of semiconductors as one (entity). Unfortunately (for them), neither of the buyouts have managed to cross the finish line. As such, we were left with three individual companies that deserve another look on a standalone basis.

In this article, we will examine closely each company on its own merits, and once our analysis comes to an end - we will also assess, rank and rate each of these three musketeers as a separate investment, going forward.

The Old (Semiconductors) Testament

In case you haven't followed the 28.5-month old (!) saga involving "The Three Musketeers," here's a recap of the main events:

October 27th 2016: Qualcomm offers to buy NXP Semiconductors for $47B

Qualcomm agreed to buy NXP Semiconductors in a deal that values NXPI at $110/share, or ~$47B, including debt, as it seeks to expand the reach of its chips from phones to cars.

The combined company was expected to have i) annual revenues of more than $30B, ii) serviceable addressable markets of $138B in 2020, and iii) leadership positions across mobile, automotive, IoT, security, RF and networking.

Spoiler alert: 16.5 months later (mid March 2018) NXPI shareholders could have sold their holdings for $124/share. Nonetheless, it took only another 9.5 months (end December 2018) for the stock price to almost halved.

November 6th 2017: Broadcom offers to buy Qualcomm

While the QCOM-NXPI deal was still stuck in the regulatory process (from which, as we now know, it won't get out...), Broadcom made an offer to acquire Qualcomm for $70/share in a deal worth ~$130B.

Broadcom made it clear that its proposal stands whether or not Qualcomm purchases NXP Semiconductors.

The $70/share would have been paid out as a combination of cash ($60) and stock ($10) represented a premium of 28% to QCOM share price at the time.

Spoiler alert: Six months later (end April 2018) it seemed like QCOM shareholders would have been better off accepting the offer, as the stock traded over 30% below the $70 mark. However, only four months later (early September 2018), QCOM shareholders could have cashed out at $76.50/share.

November 13th 2017: Qualcomm officially rejected the takeover bid from Broadcom

As expected, Qualcomm rejected the unsolicited takeover bid from Broadcom, saying the deal proposal "dramatically" undervalues the company and that it comes with significant regulatory uncertainty.

Nevertheless, even after getting an official rejection of its buyout bid for Qualcomm, Broadcom said it remains "fully committed" to the deal.

This transaction will create a strong, global company with an impressive portfolio of industry-leading technologies and products, and we have received positive feedback from key customers about this combination.

We continue to believe our proposal represents the most attractive, value-enhancing alternative available to Qualcomm stockholders and we are encouraged by their reaction.

Many have expressed to us their desire that Qualcomm meet with us to discuss our proposal. It remains our strong preference to engage cooperatively with Qualcomm's Board of Directors and management team. - Hock Tan, Broadcom's CEO

February 20th 2018: Qualcomm increased its offer for NXP to $44B

16 months (!) gone by since the initial offer, yet Qualcomm decided to increase its NXP Semiconductors offer (from $110/share) to $127.50/share, as well as accepting a minimum tender threshold of only 70% of outstanding shares (down from 80%). At that time, Qualcomm already reached binding agreements with nine shareholders of NXPI who collectively owned (at the time) more than 28% of outstanding shares.

March 14th 2018: Broadcom backs off from Qualcomm offer

After many rounds of negotiations, Broadcom decided to officially cancel its offer to acquire Qualcomm (as well as its slate of director nominees for Qualcomm’s board), as the US government (would anyhow) blocked the deal in light of national security concerns.

This decision is based on the facts and national security sensitivities related to this particular transaction only and is not intended to make any other statement about Broadcom or its employees, including its thousands of hard-working and highly skilled US employees. - Steven Mnuchin, US Treasury Secretary and CFIUS chair

July 20th 2018: Qualcomm extends its cash tender offer for NXP until July 25th = the deal termination date.

At that point, it was clear that the deal is stuck waiting for regulatory approval in China. As such, it's no wonder that only ~18.3M (or 5.3% of outstanding NXP) shares were tendered.

July 26th 2018: Qualcomm CEO blames trade war for NXP deal failure

In a CNBC interview Steve Mollenkopf, Qualcomm CEO, said that the NXP deal “got caught up in a trade war,” yet he doesn't see the trade war as a risk to the company's overall business in China.

That being said, we thought it was important to bring certainty to the process, move on and really focus on the things that we said are going to drive value. - Steve Mollenkopf, Qualcomm CEO

Walking away from the deal means that Qualcomm need to pay NXP a breakup fee of $2B.

December 3rd 2018: Qualcomm sees no prospect for the NXP deal despite (the trade truce, leading to) better chances of approval

Following the temporary trade war ceasefire between the US and China, President Trump revealed that if Qualcomm's $44B deal for NXP Semiconductors came back to Xi Jinping, he would "most likely approve it quickly."

In response, a Qualcomm representative told Reuters that although the company was grateful to learn of the (president) comments, the deadline for that deal is long due, thus Qualcomm considers the matter closed.

Spoiler alert: While both QCOM and NXPI have seen their stock prices going wild, losing 36% and 46%, respectively, from their 52-week highs, AVGO stock price to shares has been cruising relatively safely all along this M&A saga. When it tanked, this had nothing to do with QCOM or NXPI, rather with its $18.9B takeover of CA Technologies (CA) in July 2018.

The New (Semiconductors) Testament

We can sum up the past 28.5 months' fascinating saga with one sentence: Much ado about nothing.

After wasting lots of time and energy, each of the three companies has been left on its own, for good (to some) and for bad (to others).

Let's see how this trio is looking right now and which one, if any, is worthwhile buying, selling or holding.

  • Market Cap

First of all, it's important to note that AVGO alone has a market size which is 14% larger than the market-cap sizes of QCOM and NXPI combined.

This leaves NXPI as the more vulnerable name here, due to (lack of) economies of scale, compared to the other two.

  • Revenue (Quarterly)

AVGO is in a league of its own here. Over the past five years, Broadcom has managed to consistently increased its revenues by over 50% (annually) on average. Meanwhile, NXPI annual average revenue growth was 14%, and QCOM has grown backwards...

  • EBITDA (Quarterly)

A very similar picture to the revenue growth rate, but an even more radical.

AVGO with 63% compound annual growth, NXPI with 21% (1/3 of AVGO), and QCOM going from bad to worse.

  • Operating Income (Quarterly)

Do we really need to repeat ourselves for the third time in a row or has this reality sank in already?

Interestingly, in-spite of its overall growth, NXPI hasn't been able to translate this to increase its operating profit. The top line/s haven't trickled into the operating income line.

  • Net Income (Quarterly)

Nevertheless, when it comes to bottom line, NXPI did manage to translates its growth to net income.

Meanwhile, QCOM continues to see basically everything shrinking - fast and furious.

Mo matter how we spin this (recall that as the moderators of the Wheel of FORTUNE, we certainly like to spin...), when one is looking at the numbers over the past five years - there's only one way to interpret the results: Broadcom is on a league of its own.

You also may wish that QCOM is on a league of its own - and definitely not in a good way. Using English football, i.e. soccer, league system I'd say that if AVGO is playing in the Premier League (Top level), NXPI and QCOM are playing in the Championship (Level 2), with the latter at a real risk of being relegated to League One (Level 3), if things won't improve out there quickly.

The New (Semiconductors) Testament

As we all know, past performance is not an indicator of future performance, and that goes for (past) good and bad times alike.

Therefore, let's try to look at the current shape, as well as the foreseeable future, of this trio of semiconductors (SOXX, SMH).

  • Dividend Yield (Trailing Twelve Months)

Due to the extreme weakness of Qualcomm, the dividend yield (based on a $0.62/share quarterly distribution) is now super attractive at 4.5%.

However, it's important to note that Broadcom has recently increased its quarterly dividend by to less than 51.4% (!!!) to $2.65/share. At this level of distribution (assuming this is going to hold from now on), we are talking about a dividend of circa 4%. Even here, and even at this stage, AVGO is giving more than just an equal fight.

Note that NXPI just announced (last week) a quarterly dividend of $0.25 per share (to be paid on April 5, 2019, to shareholders of record as of March 18, 2019). Should this level of distribution holds along the year, the dividend yield of NXPI based on current share price ($93.40) would be 1.07%. Not zero (as the below chart suggests), but not much above zero either; certainly not in the same ballpark where QCOM and AVGO are.

  • PE Ratio (Trailing Twelve Months)

Remember the "English Football League" system? Well, here, QCOM isn't only in League One (Level 3), but probably in League Two (Level 4)... Nowhere near its competitors that are showing attractive multiples, especially you-know-who... that company who play in the Premier League.

  • PE Ratio (Forward)

Things are getting much more interesting when it comes to the forward P/E. Here, the differences are much smaller and it's a much closer contest. Having said that, if you compare the forward P/E of QCOM (below chart) to the actual-TTM P/E (above chart), over the past five years, you'll find that the forward P/E is extremely unreliable when it comes to Qualcomm.

Mr. Market endlessly (and desperately) expects the company profitability to improve, over and over again, but no improvement has yet to come.

Will 2019 (or 2020) be the year of real improvement?

  • Revenue Estimates*

*For Current Fiscal Year, Next Fiscal Year, and Two Fiscal Years Ahead

Here are the current market revenue estimates for the foreseeable future:

Now, let's present the above data a bit differently:

Source: Author, based on Y-Charts data (as of 3/13/2019)

What can we learn out of this table when it comes to future revenue growth?

  1. AVGO remains in a league of its own.
  2. The current fiscal year is going to be tough for QCOM and NXPI.
  3. Past growth is indeed no indication for future growth. The latter is going to be much softer.
  • EPS Estimates*

*For Current Fiscal Year, Next Fiscal Year, and 2 Fiscal Years Ahead

Here are the current market EPS estimates for the foreseeable future:

Now, let's present the above data a bit differently:

Source: Author, based on Y-Charts data (as of 3/13/2019)

What can we learn out of this table when it comes to future revenue growth?

  1. AVGO is in a league of its own, here, too. However, not the same top one we've got used to see it in. 2018 was an exceptionally profitable year for AVGO and the company is unlikely to maintain the same levels of EPS.
  2. If we believe these estimates, QCOM is the horse to bet one, coming behind the pack to lead the race, at least from an EPS growth perspective.
  3. Past growth is indeed no indication for future growth. The latter is going to be much better for QCOM and NXPI, less for AVGO.

How Did We Play This Out

There's no doubt regarding the identity of the winner of this race. It's Broadcom, by a wide margin. As such, we only traded AVGO over the past year and even then - only when a real opportunity presented itself.

Similarly, in light of the great uncertainty (thus volatility) that surrounded this trio of semis - while juggling and negotiating M&A deals - we avoided getting involved with both QCOM and NXPI. Sometimes it's better to miss an opportunity with a limited upside potential than participated in it with a (significantly) less limited downside risk.

But before we dive into our action, let's refresh our minds again with the main events that took place since early 2018 to date, using the below chart:

No. Date
1

November 6th 2017

November 13th 2017

Broadcom offers to buy Qualcomm

Qualcomm rejected the takeover bid from Broadcom

2

February 20th 2018

March 14th 2018

Qualcomm increased its offer for NXP to $44B

Broadcom backs off from Qualcomm offer

3

July 20th 2018

July 26th 2018

Qualcomm extends its tender offer for NXP until July 25th

Qualcomm CEO blames trade war for NXP deal failure

4 December 3rd 2018 Qualcomm sees no prospect for the NXP deal

With the above chart in mind, here's how we play/ed AVGO, at the Wheel of FORTUNE, over the past year:

1. Buying AVGO at $200/share

Following the acquisition of CA, AVGO share price tanked over 20% very quickly. As soon as we saw this, we knew that this is a fantastic opportunity to step in.

Source: Wheel of FORTUNE. Trading Alert, July 12th 2018

Carrying a risk rating of 2.5 (on our 1-5 scale) means that the maximum allocation we believe to be appropriate here is 6%.

Note that maximum allocation doesn't equate suggested allocation.

2. Selling a covered call: AVGO 1/17/2020 $260.00 for $27.60

Since our price target ("PT") for AVGO was $275-$300, and following a rapid run-up of over 20% in a matter of only 70 (calendar), we decided to sell this covered call which secured our PT, based on the the midpoint ($287.50)

Source: Wheel of FORTUNE, Trading Alert, September 20th 2018

As you can see in the below image (option sale scenarios), should the option get assigned to us - we will see a net price of $287.60 for the position, combined of the strike price ($260) plus the premium we received ($27.60). That's a hair above the midpoint PT of $287.50.

Retrospectively, we sold this covered call way too early when the stock was trading at ~$245. Nonetheless, almost six months later and the highest AVGO stock price traded at was $286.63, still below what we may net ($287.60) if the option gets assigned to us.

Outlook and Price Targets

Here are the forward-looking outlook at the three companies have provided during their last earnings report (for the fourth quarter of 2018):

Jan. 30, 2019: QCOM, on the other hand, came out with an in-line (fiscal) Q2 guidance that sees revenues of $4.4B-$5.2B (vs. the consensus of $4.8B), and EPS of $0.65-$0.75 (vs. the consensus of $0.69). It's important to note that this guidance doesn't include QTL revenues for royalties due on the products from Apple (AAPL) and its contract manufacturers. On the other hand, the guidance does include $150M in royalties in an interim agreement with Huawei, which was the previously undisclosed licensee in the dispute.

Feb. 6, 2019: NXPI came out with a downside Q1/2019 guidance, seeing revenues of $2.02B-$2.16B (vs. the consensus of $2.25B).

AVGO is due to report its fiscal Q1 earnings today (Thursday, March 14th), after market close. The consensus is for EPS of $5.22 (+2% Y/Y) and revenues of $5.83B (+9.4% Y/Y). Having said that, in the last earnings report (Dec. 6, 2018) the company provided guidance for full-year 2019 that sees revenue of $24.5B (vs. consensus for $22.58B), and an operating margin of 51%.

As you can see below, the downbeat guidance of NXPI is being reflected in the EPS estimates that fell sharply, over the past few months. The market consensus is now lower by over $1/share, for each 2019 and 2020, than it was only three months ago.

Source: Author, based on Wall Street Journal Data (as of 3/13/2019)

At the same time, the estimates for both QCOM and AVGO remain very stable and haven't changed much.

As for what Wall Street sees for the three companies when it comes to PTs, it's quite a unified picture so frankly, we take it with a grain of salt.

AVGO, QCOM, and NXPI price targets and analysts

Source: Author, based on Wall Street Journal Data (as of 3/13/2019)

Having said that, here are few quick-immediate observations:

1. The ratio between the average upside (based on the highest PTs) to the average downside (based on the lowest PTs) is 4.27 (=37.31/8.74), quite an upbeat ratio!

2. The more reasonable averages (average and median PTs) point at about 10%-11%. Nice, but certainly not that upbeat I'd say.

3. QCOM has the least downside risk (per lowest PTs) and the most upside potential (per highest and average PTs). Interesting...

Bottom Line

NXPI remains a risky bet in our view. We believe that the stock is a conditional hold at best, meaning that should we've held the stock right now - we would sell covered calls right away, and if the stock price moves to the triple-digit range - we would sell the stock straight.

AVGO remains our go-to-guy in here. We have reiterated the stock as one of our top pick among the information technology sector (QQQ, XLK, VGT, FDN, IYW) in our "Getting Ready for 2019" 19-part series.

Nevertheless, we believe that the valuation isn't cheap anymore, and therefore, we treat the stock as a classic hold at this stage, while strongly suggest to sell covered calls with strikes of $280-$290 that, together with the premiums they pay, take the investor over the $300 mark (where we believe the stock is fully priced).

As for QCOM... This is the most interesting name of the trio in our opinion, going forward.

Qualcomm has suffered (financially) from a long legal fight with Apple that has led to the iPhone maker (and a second unnamed licensee) to withhold royalty payments. Qualcomm has revealed another setback in its recent earnings call, confirming that Apple won't use its modems in its next product launch.

Finalizing the NXP acquisition could have strengthened Qualcomm position, but that's now also history.

At the end of the day, it's all about valuation.

In order for us to buy QCOM, we would like the stock to trade in-line with AVGO, i.e. with forward P/E of ~12x. Based on the company's EPS estimate for 2019 of $3.82, this would require the stock to trade at ~$45.84 in order to make it attractive enough for us to dive in.

However, using the 2020 EPS estimate of $4.54, one may argue that even $54.48 is a fair valuation.

At the moment, we have no rating for QCOM but if the stock moves to the mid 40s area - rest assured we will be waiting for it, one way or another...

Disclosure: I am/we are long AVGO. 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.

Additional disclosure: Short AVGO 1/17/2020 $260.00 (covered) CALL

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.