It's been a rough past 12 months for mobile chip giant Qualcomm (QCOM +5.31%).
As recent momentum from other tech giants like eBay and Google push the Nasdaq into fresh highs, Qualcomm has been a rare laggard amid the surging sector. And unfortunately for Qualcomm shareholders, the outlook for a number of recent issues further cloud the investment outlook for what many tech investors, myself included, once regarded as one of the more compelling business models in all of tech.
Sour Apple
Recently, a number of sell-side analysts reported that Qualcomm was experiencing challenges in the most recent round of negotiations with tech giant Apple (AAPL 0.02%). Specifically, Apple, true to form, apparently demanded more favorable pricing from Qualcomm for the innards it supplies for the iPhone and iPad.
Indeed, Qualcomm lists Apple, through its Asian assembly partners, as contributing more than 10% of its annual revenue for the past three years, per the SEC's reporting requirements for significant customers. The exact degree of pricing concession Apple wants from Qualcomm remains unclear.
However, Apple has a track record of exacting painful discounts from suppliers beyond what many deem "good taste." The company's knife twisting has come back to haunt once-high growth suppliers including Cirrus Logic, Invensense, and GT Advanced Materials, its sapphire supplier whose subsequent bankruptcy many attributed in no small part to the terms of its stringent deal with Apple. Qualcomm's size gives it a distinct advantage over those smaller players, but it's likely that Apple's tendency to coerce its suppliers will negatively impact margins in its CDMA Technologies segment. Unfortunately, the hits to Qualcomm extend well beyond Apple.
Stung by Samsung
Adding to Qualcomm's financial woes, Korean smartphone giant Samsung (NASDAQOTH: SSNLF) cut Qualcomm's application processors out of the Galaxy S6 and S6 Edge entirely, in favor of Samsung's internally developed Exynos processor. Many analysts predicted this move given Samsung's experiment using its own chips in some Galaxy S5 models last year, and the Galaxy S5's excessive bill of materials.
Thanks to its historical specialization in CDMA connectivity, though, Qualcomm still supplies the baseband modem in at least some models and geographies for the most recent Galaxy phones. However, losing the key application processor slot should additionally pressure Qualcomm's financial performance, even if it manages to regain its way into future Samsung Galaxy or Note models, as some analysts believe.
A contrarian investment?
These two developments certainly bode poorly for Qualcomm's stock during the next 12 months. It's no surprise that I saw at least one analyst downgrade Qualcomm stock in reaction to the Apple news.
However, despite the myriad of external pressures currently weighing on Qualcomm's business and stock price, the company remains a key cog in the mobile supply chain, and the fact that neither Apple nor Samsung can entirely part ways with Qualcomm reinforces this slight silver lining. So is there a contrarian case for Qualcomm?
I'm not sold on this narrative for a few reasons. For starters, although its shares have suffered recently, Qualcomm's trading multiples remain above what I view as bargain levels. See for yourself.
QCOM EV to EBITDA (TTM) data by YCharts.
Additionally, looking beyond its problems with Apple and Samsung, Qualcomm faces pressure in its ultra-lucrative Technology Licensing segment, as well. Earlier this year, Qualcomm resolved its antitrust suit in China by agreeing to pay just less than $1 billion in fines, and to reform the structure of its licensing deals with Chinese OEMs. The royalty rate Qualcomm charges its licensees in China will remain largely unchanged.
However, this suit carries with it a serious moral hazard for Qualcomm's chief cash cow division. The EU's antitrust watchdog recently opened a similar investigation into Qualcomm's licensing practices. All told, it appears that the doors have been opened to possibly resetting some of the economics of Qualcomm's IP-licensing business on a global scale, and that presents a massive risk factor to the company's ongoing success.
Between the difficulties with chip suppliers and the potential overhang challenges with its licensing division, Qualcomm appears to be a stock that's cheap for a few very valid reasons. A number of these issues could dissipate in the coming months, which would pave the way for a potential rally in Qualcomm shares. While investors might want to avoid the stock today, they might also benefit from keeping a close eye on the company as the key storylines further play out in coming quarters.
