There has been some speculation among analysts that with Qualcomm (NASDAQ:QCOM) evaluating the potential to split itself into two entities -- technology licensing as one business, chips as another -- Intel (NASDAQ:INTC) would essentially be the perfect buyer for the chip business.
From the perspective of an Intel stockholder, such a deal seems quite compelling. Were it to happen, Intel would, practically overnight, become the world's top merchant vendor of mobile applications processors and inherit a set of mobile technologies and teams that are arguably the best in the business.
It would also get Qualcomm's sizable chip-related revenue stream and customer base, becoming the world leader in mobile computing and communications technology. Over time, Intel could then transition Qualcomm's chips away from third-party manufacturing to in-house technologies, potentially giving Qualcomm's chip business an unbeatable cost structure.
How much would it cost Intel to buy Qualcomm QCT?
Stacy Rasgon, a well-respected analyst with Sanford Bernstein, in a sum-of-the-parts valuation of Qualcomm, pegs QCT as being worth anywhere from $10 per share to $25 per share.
Let's be conservative and assume that Qualcomm won't let QCT go cheap to a potential acquirer and asks $25 per share for it. At Qualcomm's current share count of 1.57 billion, this would be a $40 billion buy. Although this seems really large, I believe that this would create more value over the long term than buying back $20 billion worth of its own stock.
Justifying that claim
The way I view this is by looking at the kinds of earnings-before-tax that Qualcomm's chip business can generate and the kind of interest expense that Intel would need to pay on debt borrowings of $40 billion.
If we assume Intel borrows this $40 billion at 5% interest (this is probably on the high side), then this would imply annual interest expense of $2 billion. As long as Qualcomm's chip business can generate in excess of this in net income per year, then this shouldn't be a problem.
The question then is, "Can it?"
Qualcomm CEO Steve Mollenkopf believes that the company's chip business -- assuming current tough market conditions -- will see operating margins of 16% or greater by the fourth quarter of the company's fiscal year 2016.
If we assume that Qualcomm QCT can achieve annual revenue of approximately $17 billion in fiscal 2016 (a slight increase from the implied number for the current fiscal year), then 16% operating margin would imply operating income of $2.72 billion. This seems to be enough to cover the interest expense associated with borrowing $40 billion at 5%.
How would this create value, though?
It isn't enough to show that Intel could make just enough from such a potential acquisition to just cover interest expense. Such a deal would need to fundamentally create value for the company. I believe it would.
The value creation would happen in a few parts. First of all, Intel already has an organic modem/RF/mobile applications processor effort that it could shutter if it were to acquire Qualcomm's chip business. Intel CFO Stacy Smith indicated at the company's 2014 investor meeting that mobile-specific spending (beyond shared IP development) is on the order of a "couple hundred million dollars per quarter."
This relatively fruitless (thus far) spend, as well as well as some other spending (internal cellular and connectivity spending, for example), would go away.
The next way that such a deal might create value is in the same way that Intel expects its acquisition of Altera to: It would eventually be able to transition Qualcomm's chip manufacturing to Intel factories.
Since in this case, Intel/Qualcomm would eventually be able to cut out the semiconductor foundries, there's a good chance that Qualcomm's chip business would have the best chip manufacturing cost structure in the mobile industry.
This, if my hypothesis is correct, could allow Qualcomm to either improve its per-unit margins or grab even more market segment share by lowering prices while keeping its current margin profile.
Will this deal happen? Probably not
As interesting as this deal could potentially be, I'm not convinced it will happen. Intel will have its hands full trying to integrate its recent large purchase of Altera, so trying to integrate something even larger so soon may introduce significant execution risk.
Furthermore, Intel's management and board of directors may believe that the company can deliver more value (or begin to deliver value sooner) by continuing to push its organic mobile chip development efforts.
Additionally, if Qualcomm management and board of directors come to the same conclusion as Street analyst James Faucet has that splitting the company into two would be "value destructive" (and I think there is a strong chance of this) then this speculation is ultimately moot.