According to Reuters, hedge fundJana Partners wants Qualcomm (NASDAQ: QCOM) to spin off its wireless chip business in a bid to unlock value for Qualcomm shareholders. Jana Partners also reportedly wants Qualcomm to speed up share repurchases, "improve disclosures and refresh its [board of directors]."
Let's a take a closer look at whether this actually makes sense or not.
A quick and dirty sum-of-the-parts valuation
In order to get a sense of what kind of value could potentially be unlocked if Qualcomm were to spin off its chip business, I'd like to do a quick and dirty "sum of the parts" valuation of Qualcomm. In other words, I'm going to consider Qualcomm's QCT and QTL as independent businesses and try to come to reasonable valuations for both.
First, let's start with QTL. In Qualcomm's fiscal 2014, the division generated $7.57 billion in revenue and earnings before tax of $6.59 billion. Assuming an effective tax rate of 14% (what Qualcomm had to pay in 2014), then this would imply net income attributable to this business of $5.67 billion.
If we assume a sub-market multiple of 17 times earnings for QTL, then this implies a market value of $96.39 billion.
Now, note that Qualcomm's chip business, known as QCT, generated $3.807 billion in pre-tax profits. Again assuming a 14% effective tax rate, this implies net income of $3.27 billion. I would say that there's more risk for Qualcomm's chip business than its licensing business, so I'd assign it a lower multiple than I would QTL. Peer MediaTek trades at about 14 times earnings, so let's be conservative and use that same multiple for QCT.
This would imply a market valuation of about $45 billion.
Summing up QCT and QTL based on this analysis implies a market capitalization (including cash on the books) of just over $170 billion -- a 49% premium to where the stock currently sits, as of writing.
Would splitting up the company be a good idea?
If the analysis above is in the right ballpark, then it does look like Qualcomm is undervalued from a "sum-of-the-parts" perspective. However, while this might mean that splitting the company into two would unlock shareholder value, I'm not so convinced.
For example, QTL acts as sort of a "cash cow" to support the relatively high growth QCT. Having a reasonably secure and quite large profit stream from QTL likely affords QCT the ability to more freely take risks on "moonshot" projects.
If QCT had to go at it independently, then I wouldn't be surprised if management of that company managed expenses and risk far more tightly than it does now. This could be good for near-term and even medium-term profitability, but it might hamper the company's ability to more aggressively go after adjacent business opportunities.
I wouldn't want to see it, but thanks for the reminder, Jana!
As a Qualcomm shareholder, I wouldn't like to see QCT and QTL spun off. However, also as a Qualcomm shareholder, I do appreciate the "reminder" that it gave to the market about how undervalued the company seems to be. Qualcomm is the largest wireless chip vendor in the world and also mints billions in profits by collecting royalties on worldwide 3G/4G device sales.
I think such a high quality business deserves a greater-than-15 times earnings multiple.
