Qualcomm: Life After Litigation?

07/28/2017 2:50 am EST

Focus: TECHNOLOGY

Stephen Mauzy

Income-Investing Specialist, Wyatt Investment Research

Qualcomm (QCOM) is a buy on our "dividend growers" list; we also note that the firm has been hit with a deluge of legal battles in 2017, notes Stephen Mauzy, editor of High Yield Wealth


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It began early in the year when an arbitrator forced Qualcomm to pay $940 million to BlackBerry (BBBY) after Qualcomm lost an arbitration ruling on royalty payments. The arbitration award settles a dispute between the two companies that dates to 2010.

BlackBerry is pocket change in the grand scheme of Qualcomm’s business empire. Apple (AAPL) and Samsung (SSNNF) are Qualcomm’s two largest customers.

The former has essentially blocked licensing payments that previously went to Qualcomm for iPhone sales. Apple believes that Qualcomm’s royalty fees are excessive. Qualcomm, in turn, sued Apple for breach of contract.

Qualcomm has lost the initial royalty battle with Apple. Apple continues to withhold royalty payments. We think Qualcomm will eventually win the war.

Qualcomm’s royalty demands hardly appear excessive compared to the value of its technology. While a top-tier iPhone 7 sells for $700, Qualcomm’s per-phone royalty fees are less than what Apple charges for a wall plug, approximately $19.

That said, Wall Street analysts are worried that a trend could emerge. They worry that other smartphone manufacturers could follow Apple’s lead and cease paying Qualcomm for its intellectual property. Qualcomm shares are down 18% year to date. 

Unlike the Wall Street analysts, we’re more sanguine on the royalty-payment matter. Despite its legal battle with Apple, Qualcomm will continue to supply chips and technology used in iPhones and iPads.

Apple has no reasonable alternative, which means it has no alternative than to eventually pay Qualcomm’s for its chips and technology. 

The imbroglio with Apple is an immediate drag. Specifically, it’s a drag Qualcomm’s revenue and earnings. Qualcomm forecasts fourth-quarter (next quarter) revenue of $5.4 billion to $6.2 billion. It forecasts EPS of $0.55 to $0.65. A year ago Qualcomm booked $6.2 billion in revenue and earnings of $1.07 a share.

The outlook is cloudy if we look only to the tip of our nose, but look to the horizon and blue skies appear. Although Qualcomm faces immediate problems, its long-term outlook looks promising.

In the mobile segment, Qualcomm’s CDMA technologies (QCT) business continues to grow in the competitive China market. The company’s QCT operating segment generated approximately $4 billion in revenue in the third quarter, a 5% year-over-year increase.

Qualcomm continues to exploit its advantage in several other key growth areas, such as 5G wireless services, ARM-based servers, and deep learning. The company said that the revenue generated from these growth segments was up nearly 30% year over year.

Beyond smartphones, Qualcomm has invested in chip technology used in automobiles with the $47-billion acquisition of NXP Semiconductors (NXPI) last November. NXP is one of the world’s largest developers of chips for automobiles.

Qualcomm is betting big on cars becoming the next smartphone — a device that rolls together communications and services once handled by several other devices.

NXP will be an immediate shot of adrenaline to Qualcomm’s top line. NXP's revenue increased 56% to $9.5 billion last year. We think NXP is a smart bet to exploit an inevitable trend. 

And we think Qualcomm high-yield dividend is a smart bet. Qualcomm has increased its dividend annually since 2003. The latest increase lifts the quarterly payment 10.4% to $0.57 per share.

The downdraft in Qualcomm’s share price and the uplift in the dividend payments raises the dividend yield to a tempting 4.2%. 

We recommend investors give into temptation. Qualcomm generates cash to an extent few companies can emulate. Despite Apple withholding royalty payments this year, Qualcomm ended the latest quarter with $38.7 billion in cash and marketable securities — up from $31 billion the prior year.

Qualcomm is arguably the best buy among our dividend-growth recommendations. It offers a dividend that yields 4.2%.

Once the legal imbroglio with Apple subsides, the drag on revenue and earnings growth will subside. We easily see a 50% increase in EPS once Apple returns to paying the royalties it rightly owes Qualcomm. 

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