A diary of the thought process behind my investment decisions
Qualcomm : The Biggest Bargain In Large Cap Tech
Qualcomm (QCOM) owns patents related to 3G, 4G & 4G LTE technologies (among others) that power smartphones. As a result Qualcomm receives a roughly 3% royalty on most smartphones sold in the world. Getting 3% of every smartphone sold seems like a pretty good business to be in but the market does not value Qualcomm that way.
Qualcomm trades at a roughly 10% free cash flow yield or 10 times earnings once one adjusts for the roughly $30 billion in cash they are hoarding. The reason for this valuation is that Qualcomm owns a second, less attractive business. Qualcomm makes chips for smartphones and this business has recently encountered more difficult competition. While semiconductors account for a smaller part of Qualcomm's profits they attract almost all the attention of analysts and investors.
If one were to put a market multiple on Qualcomm's attractive, licensing business and add back cash Qualcomm would trade at $85 versus the roughly $69 Qualcomm trades at today. However, this valuation assigns no value to Qualcomm's "terrible" semiconductor business that produces roughly $2 billion a year in profit. Even putting a ten multiple on that business would raise Qualcomm's valuation to $95.
Reasons For Undervaluation
I believe there are a number of reasons for Qualcomm's undervaluation. Qualcomm's licensing business is simple and predictable. As a result this business generates few headlines, little news and as a result receives little attention. The semiconductor business generates constant news of design wins & losses, more recently losses. As a result it seems Qualcomm's business is constantly under siege, even though its main profit engine has been chugging along. Additionally, Qualcomm is mainly followed by semiconductor analysts and investors who tend to focus solely on design wins & losses instead of keeping their eye on the main profit engine.
Qualcomm has grown its revenue nearly nine fold since 2002, attracting a number of growth investors. More recently growth has slowed due to the slowdown in the semiconductor business (even as earnings for the licensing business are growing at a double digit pace). As a result Qualcomm's investor base is transitioning from growth investors to value investors.
Catalyst For Change
An activist has recently accumulated shares of Qualcomm and nudged management to make positive changes. Instead of hoarding cash management will repurchase over 10% of the outstanding shares of Qualcomm this year in addition to paying a nearly 3% dividend. Moreover, Qualcomm has hired outside consultants to review their cost structure.
Almost every large cap technology company has had a period of transition after their explosive growth phase passed. Microsoft, Intel, Cisco, Oracle and even Apple's stock sputtered when growth slowed. In all these cases it was not until the stock became cheap and management began to return cash to shareholders in earnest that the stocks rebounded nicely. Qualcomm's stock has spent the past three years going nowhere while the market has exploded to the upside. As a result Qualcomm is now the cheapest large cap tech stock. Additionally, Qualcomm will likely return over $25 billion to investors over the next two years or greater than 22% of its market cap. If Qualcomm follows the script of any of these large cap tech stocks the stock price should rise by over 50%.
Qualcomm has always been a fast growing business that did not focus on expenses in the same manner that a mature company would. As a result there is a good chance that there are significant savings to be had by cutting expenses, resulting in improved margins. Qualcomm's margins are well below their peers even though Qualcomm has the scale necessary to have industry leading margins. Qualcomm has never undergone a major restructuring and has now hired outside advisors to review their cost structure. If Qualcomm can improve margins they can greatly improve the profitability of their semiconductor unit even if revenue declines.
Qualcomm Ventures is likely the canary in the coalmine for the amount of waste and pet projects there are at Qualcomm. Qualcomm has a venture capital subsidiary that has somehow managed to lose money during the largest venture capital bubble ever. Qualcomm has no business being in the venture capital business and should instead return this cash to shareholders. If I was able to find this huge waste of money by reading through the 10-K, I can only imagine what the consultants will find once they thoroughly investigate the business.
Qualcomm is currently undergoing a process that almost every large cap tech stock has been through. Qualcomm is now a cheap stock, with a steady business, that is returning cash to shareholders by the boatload. The Qualcomm saga feels like a movie I have seen a hundred times before and the ending is a much higher stock price.