Here’s the really important pair of numbers that explains what’s happening to Qualcomm (QCOM).
From its business of licensing patents for cell phones Qualcomm makes a gross margin of 61%.
Apple (AAPL) had a gross margin of 39% in its most recent fiscal year. Samsung Electronics, the biggest maker of cell phones, had a gross margin of 39% in its most recent fiscal year.
With smartphone sales growth flattening and competition continuing to heat up, especially for smartphones selling at the high end of the market, companies like Apple and Samsung are desperate to claw back any dollars that they can.
An anti-trust action filed by the Federal Trade Commission on January 17 seems to have provided the opening that Apple needed to put the pressure on Qualcomm to lower its royalties. The FTC action alleges that Qualcomm has used its patent power to pressure cell phone makers not to use competing chips. On Friday, January 20, Apple filed a lawsuit alleging that Qualcomm has unfairly used the power of its patents.(And besides, Apple claims, Qualcomm owes us $1 billion in unpaid rebates.)
These moves follow on a $880 million fine against Qualcomm levied in South Korea for violating antitrust laws. And that follows on a $975 million payment in 2015 by Qualcomm to settle a antitrust case in China.
The key point in the Chinese settlement, however, was that Qualcomm would be allowed to collect licensing fees in China in exchange for lower licensing royalties.
I think there’s a good chance that the FTC case will die under the new Trump administration. The vote to bring the case was 2-1 and the dissenting opinion makes a decent case against bringing the action. Moreover Qualcomm has a long history of successfully fighting off claims like this in the courts, after long delays, and I don’t see the new Justice Department having a strong commitment to a case brought at the very end of the previous administration.
I also doubt that the Apple case will ever go to trial–and I don’t think it is intended to. Instead the two companies will do what Silicon Valley (although geographically Qualcomm, located in San Diego, isn’t a Silicon Valley company) almost always do: they’ll reach a compromise settlement that will keep Apple on board as a Qualcomm customer for its next iPhone or two but also lower the royalties that Apple pays to Qualcomm. I’d expect that Apple will also collect a good part of the $1 billion in rebates that it claims Qualcomm owes.
Qualcomm has got the cash so making a big payment to Apple isn’t going to be too painful.
Which doesnt’ mean a settlement with Apple wouldn’t hurt Qualcomm. A settlement with Apple, coming after the fines and settlements in South Korea and China, will encourage other cell phone companies to launch their own efforts to cut the royalties they pay to Qualcomm. Some will win and the effort as a whole will put more downward pressure on Qualcomm’s margins at a time when the smartphone sector isn’t showing much in the way of growth. (See a reason here why Qualcomm just bought NXP Semiconductors (NXPI) in order to get into the much faster growing automotive semiconductor market?)
Qualcomm’s shares are down 18.7% since the close on January 18 including a big 12.7% drop today, January 23, to $54.88.
Which has made Qualcomm, already a member of my Dividend Portfolio, an even more attractive dividend play–even if one with a still considerable degree of share price risk. At the January 23 close Qualcomm yields 3.86%. And whatever the pressure on royalty rates, Qualcomm will be able to continue to cover its dividend and even to increase it, if not at the high rate of the last five years.
So do you want to buy Qualcomm today for the yield? It depends on where you think the stock’s bottom might be.
Technicians were pointing to a 50% retracement to $56.93 as a probable bottom. But Qualcomm blew through that. (The January 23 volume of 94.4 million shares was 10 times the average daily volume of 9.4 million shares traded.)
Next stop, one technical theory said, would be the 61.8% Fibonacci retracement to $53.48. After the tumble on January 23, the shares are just about that level. I’d note that the 52-week low on the stock is $42.24 so there is the possibility, clearly, of further retreat, but the $53.48 level does look attractive to me. (If only because that level will bring technical buying into the market.)
The fall in Qualcomm shares also comes just days before the company reports quarterly earnings after the close of trading on January 25. In the current circumstances what the company says in its guidance could well work to stabilize the shares.
If you’re inclined to take a little more risk, I’d look to buy the almost 3.9% yield here. If you want to play it somewhat move conservatively, you should wait until after the company speaks on January 25.
In any case I’m keeping Qualcomm in my Dividend Portfolio.