by Clement Thibault
Qualcomm (NASDAQ:QCOM), an American multinational semiconductor and telecommunications equipment company that designs and markets wireless telecommunications products and services including the ultra-popular 'Snapdragon' chip used in most high-end mobile devices today, reports Q3 2017 earnings on Wednesday, July 19 before the US market opens. Consensus estimates say the company will report an EPS of $0.81 on $5.22B in Revenue.
However, it's the burgeoning legal battle between the chip maker and one of its biggest customers that will likely be the main focus during the company's earnings call.
Growth: Start, Stop, Start...Stop?
At the start of the decade, Qualcomm was on a rapid growth track. However, concerns about its ability to extend its growth trend further ate into its share price, and over an 18 month decline, beginning in August 2014 when the stock was at a high of $82 until February 2016 when the stock reached a low of $42, its valuation was cut in half. The concerns proved correct; the company's revenue growth came to a halt before shrinking by about 20% on a TTM basis.
During the second half of 2016, Qualcomm saw renewed growth on a TTM basis, as well as optimism about potentially new revenue streams. As well, investor and analyst sentiment on the stock changed, pushing the share price up to a high of $71.
But just as all cylinders began firing in unison for Qualcomm once again, in January 2017 it was socked with a $1B lawsuit filed by its biggest customer, Apple (NASDAQ:AAPL). The iPhone manufacturer accused Qualcomm of engaging in anti-competitive practices "by charging royalties for technologies they have nothing to do with." Following the filing, the chip maker's stock promptly fell to the low $50s, a range in which it has been trading since, neither breaking below $50 nor pushing to $60 at the top end.
Qualcomm isn't sitting still, however. On July 7 it filed a counter suit, seeking to ban certain iPhone models from being sold in the US.
The Apple / Qualcomm battle threatens to be lengthy and damaging for both companies. But there's more to Qualcomm than just this highly public battle. The chip maker hasn't stopped developing new technology, nor has it ceased pursuing acquisitions and partnerships.
Here's why, despite many analysts assuming the contrary, we believe Qualcomm shares have the potential to double in value over the next few years.
Apple Lawsuit, FTC Investigation
When Apple filed suit against Qualcomm, the stock lost 30% of its value. This isn't because Apple is Qualcomm's biggest customer, but because Apple is attacking the legitimacy of Qualcomm's business model, calling it illegal. Apple claims Qualcomm is both selling chips and collecting royalties from licensing its technology, some of which is based on patents that Apple claims are invalid. Alongside the suit, the US's Federal Trade Comission (FTC) is investigating the allegations.
Lawsuits between companies producing components and licensing technology to each other are a messy business. Look no further than Apple and Samsung (KS:005930). The two companies have been suing each other back and forth since 2011. Nevertheless, that hasn't stopped them from working together.
The strongest argument for the Apple / Qualcomm relationship to continue rests on the fact that Qualcomm has proprietary knowledge and unique performance on offer. Apple is reportedly looking to ditch Qualcomm for Intel (NASDAQ:INTC), but would have to sacrifice both performance and speed in its premium devices, which would provide an advantage to rivals such as Samsung. Though we're keeping a close eye on how the legal situation plays out, we don't see it as a deal breaker for Qualcomm.
NXP Acquisition
In October of last year, Qualcomm announced its intention to acquire the Dutch chip maker NXP Semiconductors NV (NASDAQ:NXPI), in what was called the largest technology acquisition ever in Europe. The deal valued NXP at $37 billion, with $10 billion of debt, for a total of $47 billion dollars.
This is an acquisition we like a lot. Too often, acquisitions within the same sector promise synergies and cost cutting, but which in reality are often hard to implement after the companies merge. In this case however, NXP is leading in markets in which Qualcomm has almost no presence—in particular the Internet of Things (IoT) and the automotive industry. Together, the two companies could just about create a one-stop-shop for everything chip related. Which is why EU regulators in Brussels decided to take a closer look at the acquisition, on grounds that consumers and innovation could be negatively affected by the possible monopoly. The FTC approved the deal in April; the EU committee will announce a decision by mid-October.
Smartphone Market Share
Currently, Qualcomm controls about 40% of the mobile phone market. Their newest chip, the 'Snapdragon 835' was reportedly so strongly coveted by Samsung that they purchased Qualcomm's entire supply to power the Galaxy S8, leaving LG (KS:066570) unable to secure enough chips to launch its G6 with Qualcomm's most up-to-date chip 'inside.' LG was forced to default to an older Qualcomm chip, the Snapdragon 821, illustrating just how tightly Qualcomm controls the high- end phone market.
According to recent reports, Qualcomm's efforts to improve its mid-range chip offering is already paying off in China, where it has slowly been clawing market share from primary competitor MediaTek (TW:2454). Though MediaTek still leads with a 40% market share in that region, to Qualcomm's 30%, the trend is clear – Qualcomm is moving up in China.
Virtual Reality Hardware
Qualcomm is currently focusing more closely on its virtual reality (VR) hardware. A developer's kit was recently shipped to selected developers so they could begin crafting applications that would test the new device. At the moment, the device has no price and is not yet unavailable to consumers, but according to reports, it shows a lot of promise. Qualcomm is collaborating with Google (NASDAQ:GOOGL), and powering Google's VR offering, called 'Daydream'.
Over the next four years, the VR hardware market is expected to grow five-fold, from $3 billion in 2016 to a $15 billion in 2020 according to some estimates. Of course, it's difficult to predict the exact moment when VR will become completely mainstream, but things appear to be headed in that direction and Qualcomm is already uniquely positioned to become the primary chip maker for everything VR.
Server Chips: Intel No Longer Inside
For years, everything related to server computing was Intel (NASDAQ:INTC) territory. With its Xeon processors, Intel dominated the data center market. However, of late, Qualcomm, NVIDIA (NASDAQ:NVDA) and Advanced Micro Devices (NASDAQ:AMD) have challenged Intel for a share of the domain. And Qualcomm has something the other two challengers lack—an ace up its sleeve in the form of a collaboration with Microsoft (NASDAQ:MSFT).
Microsoft, currently the world's second largest cloud vendor after Amazon (NASDAQ:AMZN), hopes that by collaborating with Qualcomm in the development of new chips to power servers, they'll be able to reduce costs and increase profits. Having Microsoft, the second largest player in the market, in your corner has huge advantages for Qualcomm. It enhances the chip maker's ability to create technology better suited to customer needs and gains Qualcomm an extremely strong entry point to the server market.
Conclusion
Right now, with the stock trading around $55-$57 and with a P/E ratio of 18, Qualcomm's share price is almost completely based on its legal troubles with Apple and the FTC. However, as discussed above, Qualcomm's legal problems are small compared to its multi-billion dollars' worth of opportunities, whether from the Internet of Things; the auto industry via NXP; because of its mobile chips business in China; through the VR sector; or as a result of its server chip collaboration with Microsoft.
Qualcomm, rather than rest on its laurels and hope everything turns out for the best, is relentlessly pursuing opportunities in every developing technological field. While most opportunities are still in early stages, each has immense potential for Qualcomm's future revenues and growth.
It may take a bit of time for the company to fully reach its potential and we don't expect immediate returns. However, we see Qualcomm's value doubling over the next two to three years. In the meantime, there's a nice 4% dividend reward for being a patient shareholder. We unequivocally like this deal.