Why Did Qualcomm Again Rule Against Spinning-Off Its Chipset Business?

Earlier this month, leading CDMA technology developer Qualcomm (NYSE:QCOM) once again ruled out spinning-off its chipset business (QCT). The reason for this decision is that there are obvious synergies associated in running the licensing and chipset businesses jointly. Qualcomm’s licensing and chipset business go in hand-in-hand with each other, which follows from the fact that a significant portion of technology development done in QCT is also patented by Qualcomm. The company charges royalties and licensing fees from other OEMs for using its patent portfolio.

Reviewing company’s existing structure was a part of Qualcomm’s strategic realignment plan that was endorsed by Jana partners, a significant Qualcomm stockholder. ^[1] Jana partners believed that Qualcomm could create more value for shareholders by separating QCT from its licensing business (QTL). ^[2] Below we examine reasons as to why Qualcomm ruled out this idea.

Our price estimate of $65 for Qualcomm is around 30% above the current market price.

See our complete analysis for Qualcomm stock here

1) QCT R&D Used To Garner Licensing Income:

Qualcomm claims that its existing structure is highly synergetic where the two businesses—QCT and QTL—fuel each other’s growth. The company’s R&D investment in the chipset business, well ahead of time, helps it stay competitive and get an edge over other chipset makers. Having the first-mover’s advantage in leading technologies, Qualcomm has been able to drive the technology roadmap in the smartphone chipset market. The company’s fundamental inventions in modem technology add to its intellectual portfolio, which Qualcomm monetizes by licensing it to other OEMs for global deployment. Hence, licensing revenues are somewhat directly proportional to technology development in chipset business.

2) Cost And Tax Synergies Associated With The Existing Structure:

By operating as a single entity, Qualcomm claims to realize significant cost savings in SG&A and R&D expenses. The company’s licensing business contributes more than 70% to its bottom-line and the strong cash influx from the licensing business is used to fund the R&D in QCT. Moreover, Qualcomm claims to have tax synergies associated by operating as a single segment. ((Events and Presentation, Investor Relations Qualcomm, December 2015))

3) Separating Two Businesses Won’t Ease Litigation Issues:

The other reason investors wanted Qualcomm’s chipset business to be separated from its licensing business is the litigation charges surrounding the latter that weighed heavily on the company’s bottom-line in fiscal 2015. However, with the latest charges by European Commission, Qualcomm’s chipset business has also come under the limelight of regulators. European commission accused Qualcomm of predatory pricing in the region and selling chips at a discount to a major customer for exclusively using its chips.  (For more details about the EU charges on Qualcomm, read our previous article here.) Since both the segments of the company have been involved in litigation issues, separating them won’t ease problems for Qualcomm.

4) Huge Opportunity In 5G And IoT Can Drive Future Value:

We believe that the largest growth opportunity for Qualcomm over the next five to ten years is in the 5G and Internet of Things (IoT) domains. While the global IoT market is expected to grow by more than $5 trillion over the next six years, 5G will be the broadest and most encompassing evolution of wireless technology ever with data rates requirement of 1 GBPS (Gigabits per second).

We believe that Qualcomm is positioned advantageously to profit in these emerging industries. The company holds a large share of global wireless baseband revenue, and it make sense to parlay its strong wireless technologies into IoT and 5G. With the acquisition of Cambridge Silicon Radio (CSR) in 2014, Qualcomm has fortified its position in the IoT market. CSR was a UK-based semiconductor company that made Bluetooth and wireless radio frequency devices (i.e., radios) for machine-to-machine communication.

Of late, Qualcomm’s licensing and chipset revenues from smartphones have been impaired by litigation charges and the tough competition from other players, raising doubts on the company’s corporate and financial structure. However, Qualcomm’s long-term outlook remains promising as it expands in the adjacent areas, where it can leverage its existing expertise to bring next generation solutions and create more value for shareholders.

5) Existing Structure Has Worked For The Company In The Past:

Although investors have questioned Qualcomm’s business structure as it has been affected by near-term headwinds in fiscal 2015, the statistics speak differently about the company. With more than 285 3G licenses, 155 single mode 4G licenses and approximately 119,000 patents, Qualcomm had a massive 66% market share in baseband processor market and 52% market share in application processor market in calendar year 2014. ^[3] Starting from 2G CDMA-one, which was developed by Qualcomm, to 3G and 4G LTE technologies, the company has succeeded in each generation of technology by maintaining a technology leadership. We believe as Qualcomm successfully expands its reach to the next generation technologies, doubts surroundings its current business structure would subside.

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1. Qualcomm Announces Strategic Realignment Plan, Qualcomm Press Release, July 2015 [↩]
2. Jana Partners pressing Qualcomm to spin off chip business, Reuters, April 2015 [↩]
3. Events and Presentation, Investor Relations Qualcomm, December 2015 [↩]