Qualcomm (QCOM +0.02%) has suffered a seemingly endless string of bad news in recent months, which is largely why shares are down by a third so far this year.
The company lost a key design win, has mixed feelings about the iPhone's overwhelming success, continues to have issues with getting Chinese smartphone OEMs to pay up in royalties, and most recently got hit with another antitrust probe regarding its licensing practices (this time in South Korea). Shares are now trading at four-year lows amid growing investor pessimism, but this is potentially the type of situation that contrarian investors look for.
But a couple of Street analysts think the worst could be in the rear-view mirror.
Word on the Street
Bank of America Merrill Lynch recently named Qualcomm a top pick, believing the company will continue to grow its business in China and that it may finalize its "strategic realignment" plan by the end of 2015. This comes just shortly after RBC Capital reiterated an "outperform" rating on Qualcomm, noting the extremely depressed valuation levels and pointing to healthy free cash flow.
RBC Capital analyst Mark Sue estimates that the market is currently pricing in expectations for royalty rates below 2.8%, which is unrealistically low. At the same time, shares are trading at 9 times earnings ex-cash, a notable discount to peer Intel, which trades at 14 times earnings ex-cash.
Even with some potential risks going forward in the QTL licensing business, Sue believes that the market is effectively assigning zero value to the QCT chip business at current prices. Therein lies the potential opportunity if Qualcomm's headwinds can stabilize and it unlocks value through a corporate break-up.
Never say never
Do you remember when Qualcomm settled with Chinese regulators for $975 million in February? Shares jumped 5% thanks to the removal of risk. To be clear, $975 million is a fair chunk of change, but investors highly prefer the certainty of a settlement over the uncertainty of regulatory litigation. Whenever Qualcomm works everything out with South Korean regulators, the same thing will happen. But right now, the risk is feeding investor pessimism.
I was a Qualcomm shareholder for over two years, and I sold my shares in June for a number of reasons. In a matter of just a few months, Qualcomm certainly isn't clear of the fundamental challenges that I cited at the time. I sold at approximately $67, and shares are now trading 25% cheaper at under $50 as of yesterday's close.
As such, Qualcomm's risk/reward ratio has shifted substantially over the past few months, and there's a definite chance that shares are bottoming out as the negativity peaks. There are several potential positive developments that could turn the tide in the months ahead.
Qualcomm could potentially win back the flagship slot in Samsung's forthcoming Galaxy S7. Qualcomm could announce a corporate break-up and earn a higher sum-of-the-parts valuation. Further out, it will eventually announce a settlement with South Korean regulators, and it will very likely retain its baseband modem slot in the next iPhone despite Intel's best efforts to cut in on the iDance.
I won't go as far as to say that I'm decidedly interested in buying back in, but I will say that the valuation is awfully compelling right about now.
