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How Is Qualcomm Keeping Its Edge?

By Eric Bleeker - Updated Apr 6, 2017 at 9:31PM

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Taking a peek behind the curtain at Qualcomm.

Few fields move as rapidly as technology. Businesses creating outsized profits and returns for shareholders quickly get a bull's-eye painted on their back as they become targets of other companies looking to disrupt their products by selling cheaper alternatives that still prove "good enough." Not only that, but even if a company continues to dominate its particular field, other changes in technology can shift spending away from their products. Think about how Microsoft still dominates PCs but feels pressure from the sales shift toward mobile devices such as smartphones and tablets.

With that in mind, today we're looking at how Qualcomm (Nasdaq: QCOM) innovates. 

Technology companies can innovate either through acquisitions or by spending more money on research and development. We'll compare Qualcomm's spending in these areas with that of its closest peers and assess whether the company is investing enough in its future.

Research and development
Over the past five years, Qualcomm has spent an average of 21% of revenues on R&D. The following table summarizes how Qualcomm's R&D expenditures relative to revenues compare with some of the company's closest peers.

Company

2006

2007

2008

2009

2010

LTM

Qualcomm

20%

21%

20%

23%

23%

21%

Broadcom (Nasdaq: BRCM)

30%

36%

32%

36%

27%

26%

Intel (Nasdaq: INTC)

17%

15%

15%

16%

15%

15%

Source: Capital IQ, a division of Standard & Poor's. LTM = last 12 months. Dates above are calendar years; yearly total is for company fiscal years closing in that period.

As you can see, semiconductor companies maintain pretty massive R&D expenditures to keep up with the breakneck innovations across the industry. In Qualcomm's case, the company has to spend on a few fronts. First of all, it needs to continue developing patents around its central CDMA technology and to retain leadership in new wireless standards such as LTE. Research on this front feeds revenues back to its licensing business, which still produces nearly double the profit that its chipset business generates.

On another front, the company has been reinventing itself beyond wireless communications to compete in the processor market. Its new Snapdragon processor has managed to gain a dominant market share in Android phones, but staying ahead of Intel will be difficult in the coming years; the processor king has signaled that it intends a full-on blitz targeting smarthphones and tablets in the coming years. I wouldn't be surprised to see Qualcomm's R&D as a percentage of sales rise in the coming years as it defends its leadership position in mobile processors.

Acquisitions 
In technology, some of the best companies have turned growth through acquisitions into an art. IBM has adeptly spun off capital-heavy businesses such as the hard-drive and PC segments, while it focused on acquiring additional services and software expertise that have transformed its business model.

On the opposite end of the spectrum, Hewlett-Packard is often criticized for underinvesting in R&D, to the point that it has to overpay on acquisitions to catch up with its competitors.

Investors should remember, most of all, that companies are valued by the cash flow they can bring in for their shareholders over time. If companies need to continue making purchases in perpetuity to keep growing, that amounts to a reduction in cash flows, and investors should treat acquisition spending as a continuing outflow against cash flow.

Let's take a look at Qualcomm's free cash flow over the past five years against cash spent on acquisitions.

Source: Capital IQ, a division of Standard & Poor's. LTM = last 12 months. Dates above are calendar years; yearly total is for company fiscal years closing in that period.

From a historical perspective, we see that the company hasn't been highly acquisitive in the past five years. That's good, because it reveals that Qualcomm's cash flows are indicative of its organic ability to grow. In the future, Qualcomm might change course, with its $3.1 billion purchase of Atheros last year signaling that the company will be aggressive in finding ways to make Snapdragon more competitive.

Final thoughts
Looking at Qualcomm's R&D and acquisition track record, we see the profile of a company that must spend vigorously to defend its intellectual property in the mobile space. The payoff has been that the company has a strong patent portfolio and long-term contracts with nearly every major handset maker that assures a royalty on every data-capable phone sold. Investments in chipsets such as Snapdragon should probably mean even more R&D and acquisitions down the road. That's not a bad thing, especially considering Qualcomm's history of failed acquisitions in areas such as telecom carriers. Focusing on improving the company's long-term standing in the mobile-processor and communications space should offer a far better reward for long-term investors.

To get up-to-date Qualcomm news and analysis, add the company to your watchlist today.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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