Qualcomm's (QCOM -1.75%) 10% decline since the beginning of the year was disappointing, especially when compared to the Philadelphia Semiconductor Index's gain of more than 20% during the same period.
Many investors have since turned bearish on the stock, due to the seemingly endless barrage of bad news and weak growth forecasts for the year. There are certainly reasons to sell Qualcomm after its lackluster performance, but I believe that investors shouldn't do so based on the following three bear cases.
Image source: Qualcomm.
1. The headwinds facing its mobile chip business
Qualcomm's mobile chip business, which generates most of its revenue, has been ceding market share to cheaper rivals like MediaTek and first-party chips from OEMs like Apple (AAPL -0.57%), Samsung, and Huawei. The bears claim that this trend will continue for the foreseeable future.
However, the bears often ignore two key facts. First, Qualcomm's top-tier Snapdragon SoCs are still considered the industry standard for mobile chipsets. That's why flagship devices like Samsung's Galaxy S8 and Sony's Xperia XZ Premium both use its high-end Snapdragon 835 processor.
Samsung's Galaxy S8. Image source: Samsung.
Second, Qualcomm is expanding its Snapdragon lineup to adjacent markets -- including drones, connected cars, action cameras, wearables, Internet of Things (IoT) gadgets, and data centers. These variant Snapdragon chipsets should gradually diversify Qualcomm's chipmaking business away from smartphones over the next few years.
2. Its ugly battles with regulators and other tech companies
Many recent headlines about Qualcomm focus on its ongoing battles with antitrust regulators and major tech companies across the world. These parties allege that Qualcomm leverages its portfolio of wireless patents to squeeze out high royalty fees from OEMs while forcing smaller chipmakers out of the mobile market.
Qualcomm was already fined in China, and it agreed to lower its royalty fees for Chinese OEMs; and South Korea, where it's currently appealing the fine. It also faces similar probes in the U.S., Taiwan, and Europe. Intel and Samsung recently sided with the FTC in the U.S., while Apple sued Qualcomm in the U.S. and China over unpaid rebates from their exclusive partnership.
The bears claim that this growing mess will cut deeply into Qualcomm's bottom line, since the high-margin patent licensing business generates the lion's share of its profits. Re-negotiations of the fees could certainly crimp Qualcomm's near-term earnings growth, but it's unlikely to cripple the entire business since the chipmaker still legally owns these SEPs (standard essential patents). Qualcomm can also still use cost-cutting strategies and buybacks to offset any major bottom line declines.
3. Fear of the NXP deal not closing
Qualcomm's solution to both these problems is to buy Dutch chipmaker NXP Semiconductors (NXPI -3.34%) for $47 billion. This megamerger will make Qualcomm the biggest automotive chipmaker in the world and diversify its chipmaking business into the personal security, industrial, and consumer electronics markets -- thus reducing Qualcomm's overall exposure to the mobile market.
NXP's BlueBox platform for driverless cars. Image source: NXP.
The NXP purchase would also bolster Qualcomm's patent portfolio with patents for automotive chips, NFC (near-field communications) technologies used for mobile payments, and wireless charging technologies.
This would enable Qualcomm to collect more royalties from mobile devices, and counter the argument that its method of collecting royalties on the price of an entire device (as opposed to just the 3G/4G components) is unfair. It would also give it plenty of legal leverage in its ongoing licensing battles against regulators and other tech companies.
The bears warn that the NXP deal could be blocked due to those probes and lawsuits. However, the deal was already approved in the U.S. and will likely be approved in Europe by June 9. The only market where it faces resistance is China, where the MOFCOM (Ministry of Finance and Commerce) might demand certain divestitures before approving the deal. However, there's no indication that MOFCOM plans to kill the deal -- so it would be silly to sell Qualcomm on concerns that the NXP deal won't close.
The key takeaways
Qualcomm still faces plenty of near-term headwinds, but the stock's low valuation and high dividend should limit its downside potential. The stock trades at 20 times earnings, which is lower than the industry average of 26 for semiconductor companies. Its 3.7% dividend yield is much higher than the S&P 500's average yield of 2%.
As an investor, Qualcomm has tested my patience many times before. But to sell the stock on negative news without regard for the NXP deal, its low valuation, and its dividend would be foolish. So for now, the best move for Qualcomm investors is to simply sit tight and wait for the NXP deal to close.
