Qualcomm (QCOM 1.02%), the largest mobile chipmaker in the world, was once a rock-solid investment for a post-PC world. Its mobile SoCs (system on chips) -- which bundle together an ARM-based CPU, wireless modem, and GPU -- power most Android smartphones. Its portfolio of wireless patents, the largest in the world, entitles it to a cut of every smartphone sold worldwide.
Qualcomm generated most of its revenues from mobile chip sales and most of its profits from royalties and licensing fees, and the two businesses grew in tandem for most of the past decade.
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But as the smartphone market matured and handset margins declined, government regulators and OEMs claimed that Qualcomm's license fees were too high. Rival chipmakers also claimed that Qualcomm monopolized the market by offering lower license fees to OEMs that bought its mobile chips.
Those accusations sparked antitrust probes and lawsuits worldwide, casting a dark cloud over Qualcomm's long-term growth. Let's see how those headwinds could impact the chipmaker over the next decade.
Qualcomm's biggest problems
Qualcomm traditionally supports the growth of its lower-margin chipmaking business with its higher-margin licensing unit. That simple business model, along with its dominant positions in both markets, made it an attractive investment. However, Qualcomm's licensing business now faces fines and restrictions in China, South Korea, Europe, and the United States. It also faced lawsuits from defiant OEMs like Apple (AAPL 0.53%), Huawei, and LG.
Qualcomm quelled most of those OEM rebellions, including its bruising battle with Apple, with settlements over the past two years. However, government regulators in Europe and the U.S. recently won key antitrust cases against Qualcomm -- which puts pressure on the chipmaker to detach its licensing business from its chipmaking one.
The EU fined Qualcomm for its exclusive modem deal with Apple last year and is still probing the chipmaker for forcing other chipmakers out of the market with "predatory" pricing strategies. In the U.S., a district court ruled that Qualcomm "strangled" competitors with "unreasonably high" royalty rates, unfair business strategies, and exclusive partnerships. The court wants Qualcomm to license its technologies to rival chipmakers at reasonable rates and to monitor the chipmaker for seven years to ensure its compliance.
Qualcomm is appealing these rulings, but the writing's on the wall: It needs to change its business model and pivot away from the mobile market. Moreover, Gartner doesn't expect global smartphone shipments to rise year over year until 2020 (when users upgrade to 5G devices) -- which indicates that its chip sales will peak as cries for lower licensing fees grow ever louder.
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Focusing on buybacks instead of diversification
That's why Qualcomm tried to buy NXP (NXPI 3.22%), the world's largest maker of automotive chips, in late 2016. Unfortunately, the $44 billion deal fell through last year, and Qualcomm allocated most of the cash toward a new $30 billion buyback plan instead. That move was arguably a short-sighted one that focused on buoying Qualcomm's stock price (and offsetting its generous stock-based compensation for top execs) instead of diversifying its business away from mobile chips and licenses.
As a result, Qualcomm missed chances to buy smaller chipmakers Mellanox and Cypress Semiconductor -- which were taken off the market by NVIDIA and Infineon, respectively. Qualcomm can still afford to buy other chipmakers to expand into the automotive and IoT markets, but it seems more interested in treading water with buybacks as its core profit engine remains besieged by regulators.
Qualcomm's chipmaking business also faces major long-term threats. Big OEMs like Huawei and Samsung are using more first-party chips, Apple is reportedly mulling a purchase of Intel's modem unit, and MediaTek remains a formidable competitor in the low-end and mid-range markets. China's state-backed chipmakers could also flood the market with their own baseband modems and SoCs to reduce the country's dependence on American chips.
So where will Qualcomm be in a decade?
The next decade will be challenging for Qualcomm. Slowing smartphone sales and competition will throttle its mobile chip sales, and ongoing regulatory challenges could cripple its licensing business. Qualcomm can pad its near-term EPS growth with cash from settlements with OEMs and big buybacks, but its long-term growth could sputter out unless it makes some aggressive acquisitions and moves into adjacent markets.
