Short Sellers Exit This Chip Giant

If an investor believes that the price of a stock will go down over time, that investor can borrow shares and sell them with the intention of repurchasing those shares at a lower price, thereby pocketing the difference. The concept is, in essence, "sell high, buy low."

Short selling isn't for every investor; it can be much riskier than buying shares. But the trends in the short interest -- the number of shares shorted -- are often important to watch. If a stock is seeing a rising short interest, then it means that investors are becoming increasingly bearish about the underlying company's prospects.

Qualcomm's short interest continues to decline
Qualcomm
(NASDAQ: QCOM  ) is the world's leading vendor of mobile semiconductor products and, at the same time, is the world's leading patent holder for wireless technologies. The vast majority of smartphones use Qualcomm modems and apps processors. The company is increasing its exposure to tablets and, to the extent that Windows RT succeeds, PCs. While the company recently disappointed on its top-line guidance for fiscal year 2014, investors continue to be encouraged by the company's dominant position in the mobile chip market.

It's interesting to note that the short interest peaked just around the launch of Apple's (NASDAQ: AAPL  ) iPhone 5s/5c -- when the market believed that high-end handset sales were essentially going to stagnate due to the poor performance of the Galaxy S4.  It has been unwinding fairly rapidly since, probably in no small part due to the success of the 5s. What's even more interesting is that even after the company reported a good quarter followed by much-worse-than-expected forward guidance, the short interest continued to decline. What gives?

A possible explanation
There are three big potential short theses for Qualcomm:

  1. Competition in the LTE baseband/apps processor market -- one in which Qualcomm has a de facto monopoly -- will lead to share loss and/or ASP erosion.
  2. ASP erosion in the handset market will lead to lower royalty revenues, since Qualcomm derives the vast majority of its net income from royalties stemming from the sale of cellular devices.
  3. The high-end handset market is slowing down.

While these are certainly issues, it's tough to ignore the following:

  1. Intel (NASDAQ: INTC  ) will have a competing discrete cellular baseband during the first half of 2014, but it's a stand-alone part -- the company doesn't really start to pull out the big guns until late 2014 to early 2015. Other players, like Broadcom (NASDAQ: BRCM  ) , dropped the ball and won't be competing nearly as aggressively during most of 2014. The competitive threat has been pushed back quite a bit for Qualcomm.
  2. Qualcomm is becoming much more aggressive on its capital allocation strategy, with a target of 75% of free cash flow returned to investors on an annual basis. While dividends don't introduce significant buying pressure on the shares, buybacks most certainly do.
  3. While the high-end handset market does appear to be slowing, the company is quite rapidly gaining share in the low end of the handset market. Further, with Apple looking like it's taking back share in the handset market, and with it exceedingly unlikely that Qualcomm will lose Apple content share during 2014, the effects may not hit Qualcomm as hard as chip suppliers that don't have meaningful Apple exposure.

Foolish bottom line
Qualcomm's run has been quite impressive, particularly as it seems to have been very back-half loaded. While the competitive threats from Intel, Broadcom, and others serve as a long-term headwind, there's plenty of growth to be had at the low end of the handset market from a chip content perspective as well as a royalty/licensing perspective.

The shift from 2G to 3G/LTE multimode at the low end adds more royalty streams to Qualcomm's coffers, and the company's attempts to grab more chip content within handsets -- connectivity and RF front end, in particular -- should work nicely. Oh, and that capital allocation policy isn't half bad, either.

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