"I try to buy stock in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will." -Warren Buffett
In evaluating Qualcomm I came to the conclusion that expenses
were out of control. Despite knowing this I was shocked by the admission of the
CEO of how little thought has gone into Qualcomm's spending. The following is a
quote from Qualcomm's CEO, Steve Mollenkopf, at the Merrill Lynch Global Technology
Conference a few weeks ago:
"But now we are in a position where you know looking at things like how much we are spending in R&D, are we getting the right return for R&D, are people in the right place, are we getting leverage in our supply chain" -transcript from Seeking Alpha
Steve Mollenkopf and his management team are one of the highest
paid in the world and they were not looking at how much they were spending?
They were not analyzing their return on R&D spending? They were not
maximizing their supply chain? They don't even know if people are in the right
place (whatever that means)?. What were they doing? This same management team wants
to do acquisitions before they get their house in order?
Luckily, Qualcomm's business is so "wonderful"
that even with a free spending management team that pays itself very handsomely
the business generates loads of cash. Qualcomm's licensing business alone is
expected to generate about $7 billion in EBIT next year. Qualcomm's entire
enterprise value is roughly $70 billion.
Qualcomm owns many of the patents related to 3G, 4G & 4G
LTE technology among others. Money manager Andy Macken of Montgomery Funds makes
the following analogy to Qualcomm's licensing business "It's a bit like owning the English language and then
charging anyone that learns to speak English." To which I would add, I believe more people
use 3G or 4G technology than speak English.
The
Qualcomm licensing business is a business that an idiot can run, to paraphrase
Warren Buffett. This business is expected to generate the vast majority of
profits at Qualcomm. The semiconductor business, which requires some management
skill, has performed miserably. Even though Qualcomm is the market leader in
its space with limited competition, Qualcomm has one of the worst profit margins
in its industry. Qualcomm's profit margins are less than half of what they
should be. With Qualcomm's scale there is simply no excuse for this.
Despite mismanagement Qualcomm is one the cheapest large cap
tech stocks with an expected free cash flow yield of greater than 11% (to
enterprise value). With the admission of the CEO that they weren't really
paying attention to their spending it likely means that there are easy changes
that could further boost profits. If they can get their margins to the industry
norm for a market leader the boost would be tremendous.
Activist, Jana Partners, has taken note of Qualcomm's
missteps and has been trying to prod management in the right direction. Some
positive steps are being taken including returning over 20% of the market cap
to shareholders over 2 years and a cost review by outside consultants. Qualcomm
management is going along with these suggestions but it seems to be doing so in
a half hearted manner. Qualcomm waited
months before beginning its accelerated repurchase program and then only
announced a $5 billion program. Expense reductions have not yet begun in
earnest even though management admits they are necessary. Further activist pressure
on management will likely be necessary.
Even in its current state Qualcomm is undervalued. With a management
team that finds religion (or is forcefully converted) the return potential is
tremendous.
