Qualcomm and the Patent Battles

04/28/2017 2:50 am EST

Focus: TECHNOLOGY

Stephen Mauzy

Income-Investing Specialist, Wyatt Investment Research

Qualcomm (QCOM) shares have dropped 9.3% since mid-March. Two-thirds of the loss occurred when news hit that BlackBerry (BBRY) was able extract $814.9 million in royalty refunds from the firm, says Stephen Mauzy, editor of High Yield Wealth.

The payout will leave a financial bruise, but it’s a bruise Qualcomm can easily heal. Financial bruises heal readily for a company that regularly generates in excess of $5.5 billion of free cash flow annually.

Unfortunately, we’ve been down this road before. Back in January, Apple (AAPL) filed a $1-billion lawsuit against Qualcomm, the primary chip supplier for its iPhone line of smartphones. Apple claimed that Qualcomm was a monopolist and as such it overcharged Apple for royalties on the Qualcomm chips used in its iPhones. 

When news of the Apple lawsuit hit, Qualcomm shares plunged 17%. They continued to spiral down in the weeks afterward. Shares that were priced to offer a 3% dividend yield were now priced to yield well over 4%. A buying opportunity was on offer.

Indeed, cooler heads soon prevailed and Qualcomm shares were on the road to recovery. Qualcomm shares were up 14% from the post-Apple blowout heading into April. That is until BlackBerry took its shot at the royalties Qualcomm collects.

As for Apple’s royalty claims, the lawsuit lingers, but Qualcomm has taken a more aggressive stance in defending its turf. Qualcomm recently countersued, claiming that Apple breached its agreements and encouraged regulatory attacks by misrepresenting facts.

Memories of the BlackBerry extraction will fade soon enough. The Apple imbroglio lingers, but the imbroglio should be kept in perspective.

The fact is that Qualcomm remains Apple’s best alternative for smartphone chips. Apple has courted Intel (INTC) in an attempt to kick Qualcomm to the curb. But Apple has a problem in that Intel’s chips are inferior to Qualcomm’s.

Apple’s primary competitor Samsung (SSNLF), which sold more smartphones in the first quarter of 2017 than Apple, intends to maintain its tight relationship with Qualcomm.

The Samsung’s sales trend should continue, as consumer focus shifts more toward the advantages of the new Galaxy 8 line of smartphones and away from the problems of the Galaxy 7 line.

As for Qualcomm, it’s innovating and expanding beyond smartphones. Its new Snapdragon processor for the wearables market –- watches, fitness trackers, smart headsets, and wearable accessories — is gaining wide acceptance. 

Qualcomm will expand further this year following 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.

Qualcomm has plenty of opportunities to expand the franchise in the future, and these opportunities are offered at a value price today: Qualcomm shares trade at less than 12 times 2017 EPS estimates; its peer group trades at 15 times. Qualcomm’s five-year average is 18. 

And let’s not overlook the dividend, which yields 4.3% as we write. The dividend has increased at a 15% average annual rate over the past 10 years.

Qualcomm has morphed into a first-rate dividend grower. More recently, it has morphed into a prolific buyer of its own shares. Shares outstanding have been reduced 15% since 2013.

Qualcomm has offered investors two buying opportunities in as many months to lock in a high-yield dividend yield. We suspect that the royalty-busting game among its customers is just about played out. The odds of a third opportunity are slim.

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