Shares of Qualcomm (NASDAQ:QCOM), the biggest mobile chipmaker in the world, rose just 6% this year -- a paltry gain compared to the Philadelphia Semiconductor Index's rally of nearly 50%. Let's see where things went wrong for Qualcomm, and whether or not it will fare better in 2018.
What happened to Qualcomm?
Qualcomm's licensing (QTL) business takes a cut of the wholesale price of every smartphone sold worldwide, and this high-margin business generates most of its pre-tax earnings. Unfortunately, the QTL business has been targeted by regulators in China, South Korea, Taiwan, the US, and Europe, which all claim that its cut (up to 5%) is too high.
Qualcomm was already being fined by regulators in China, South Korea, and Taiwan -- its three largest markets. It paid the $975 million fine in China, but it's still appealing the fines in South Korea and Taiwan. US regulators continue to probe Qualcomm's licensing practices, and European regulators have temporarily halted the approval of its takeover of Dutch chipmaker NXP Semiconductors (NASDAQ:NXPI) until their antitrust concerns can be fully addressed.
Qualcomm also faces an escalating legal battle against Apple (NASDAQ:AAPL), one of its top customers. Apple is suing Qualcomm for unpaid exclusivity rebates, which Apple claims were withheld in retaliation for aiding South Korean regulators, as well as unfair patent licensing fees. Apple also started withholding all licensing payments to Qualcomm, which reportedly caused another leading OEM (likely Huawei) to follow suit. That defiance fueled concerns that other OEMs could follow suit and cripple Qualcomm's entire QTL business.
As a result, analysts expect Qualcomm's revenue and earnings to respectively fall 2% and 17% this year. That bottom line decline could eventually threaten its 4.2% forward yield, since its payout ratio recently climbed above 100%:
Will 2018 be any better?
Qualcomm's near-term future looks bleak, but there are signs of relief on the horizon. First, Qualcomm must complete its acquisition of NXP. That merger would make it the biggest automotive chipmaker in the world, diversify its business away from mobile devices, expand its patent portfolio, and give it a foothold in the business of NFC (near-field communications) chips.
That move would significantly accelerate Qualcomm's expansion into adjacent markets, which already include custom chipsets for drones, wearables, connected cameras, and connected cars.
In mid-November, Bloomberg reported that Qualcomm could still close the $47 billion deal by the end of the year, despite the regulatory issues in the EU. However, activist investor Elliot Management, which holds a stake in NXP, is still pushing for a higher offer, so Qualcomm might need to raise its bid.
Another potential catalyst is Broadcom's (NASDAQ:AVGO) attempt to buy Qualcomm. Qualcomm rejected Broadcom's initial $103 billion offer, but Reuters recently reported that Broadcom is willing to sweeten the deal. Broadcom's offer could cause EU regulators to expedite the approval of Qualcomm's merger with NXP, since Qualcomm could argue that the acquisition would bolster its defenses against a hostile takeover.
Qualcomm and Apple's legal battle could also end in a cease-fire, especially if Qualcomm's ambitious plan to block all production and sales of the iPhone in China works. That would cause other OEMs to think twice before halting their licensing payments. Meanwhile, its appeals in South Korea and Taiwan might result in lower fines.
Meanwhile, Qualcomm's chipmaking (QCT) revenues should keep climbing as high-end smartphones continue using its flagship Snapdragon SoCs (system on chips). If Qualcomm maintains its lead in the chipmaking market as the QTL business moves past its legal issues, its entire business could recover. That's why analysts think Qualcomm's revenue and earnings could respectively rebound 3% and 7% next year.
So will 2018 be Qualcomm's best year yet?
I doubt that 2018 will be Qualcomm's "best" year, but I think it could be a decent year if it plays its cards right. If the NXP deal closes, Broadcom aggressively raises its bid, and the legal headwinds fade, Qualcomm could rally next year.
But if the NXP deal gets delayed, its legal battle against Apple escalates, and other OEMs also suspend their licensing payments, Qualcomm could be in serious trouble. Therefore, I think Qualcomm is a potential turnaround play next year, but it must make all the right plays without dropping the ball.