Here's Qualcomm's Plan to Boost Profits and Win Back Investor Confidence

In November 2017, chip giant Broadcom (NASDAQ: AVGO) offered to buy fellow chipmaker Qualcomm (NASDAQ: QCOM) for $70 per share, a 28% premium to Qualcomm's closing price before speculation about the bid leaked. Qualcomm shares had been significantly depressed prior to Broadcom's offer amid an ugly legal battle with Apple (NASDAQ: AAPL) that threatened to destroy Qualcomm's wireless technology licensing operation -- its biggest profit center.

Qualcomm wasn't happy with the offer, but Broadcom wasn't willing to give up so easily. In February, Broadcom bumped its offer up to $82 per share -- an offer that Qualcomm still wasn't happy with.

Though Qualcomm's board of directors rejected the $82-per-share offer, claiming that it undervalued the company, Broadcom seemed to have significant shareholder support for its offer. Indeed, Qualcomm shareholders were on track to vote out the current board of directors and vote in a slate of directors hand-picked by Broadcom to approve this deal when President Trump issued an executive order blocking the takeover bid.

Now that there's little hope of Broadcom acquiring Qualcomm -- at least while the current administration is in power -- Qualcomm will have to prove to investors that its business is truly worth more than what Broadcom wanted to pay.

Let's go over Qualcomm's plan to do that.

Fixing the licensing biz

Qualcomm operates a business called Qualcomm Technology Licensing (QTL). In a nutshell, Qualcomm has a lot of patents on key wireless technologies that are crucial for the operation of 3G, 4G LTE, and 5G cellular networks. Qualcomm licenses those patents to companies who sell devices to connect to such networks.

This is a very lucrative operation, as Qualcomm collects a percentage of the selling price of each smartphone sold worldwide. Those royalties are practically pure profit for Qualcomm, which is why QTL has historically made up the bulk of Qualcomm's profits even though it has generally generated a fraction of the revenue that its chip business has.

Unfortunately for Qualcomm, awhile back, Apple decided that it was tired of paying royalty rates on a device level, arguing that Qualcomm shouldn't profit off the technologies and features that have nothing to do with the cellular subsystems in the devices. The iPhone maker is one of Qualcomm's biggest customers.

Apple's refusal to pay (as well as another major smartphone vendor -- believed to be China's Huawei -- joining Apple in refusing to pay) is seriously damaging QTL's financial results. Just last quarter, Qualcomm reported a 44% decline in QTL revenue and a whopping 57% decline in operating income.

Qualcomm believes that it'll be able to resolve the dispute with Apple in a way that restores a significant amount of the revenue and profit lost from Apple's refusal to pay. That would be good news for the company and its investors.

Chip growth opportunities

Although Qualcomm's hope is that QTL gets back on track and continues to deliver a substantial amount of profit, the company also wants to significantly grow its chip business.

To achieve this, Qualcomm is taking a multipronged approach. Qualcomm's chip business mainly sells chips into smartphones, so on that front, Qualcomm wants to increase the amount of dollar content that it sells into a typical smartphone. It's doing this by building a wide array of technologies that are complementary to its applications processors and modems, such as fingerprint scanners, 3D-sensing technology, radio frequency front-end chips, and more.

Qualcomm isn't just betting on improving its core smartphone chip business, though. The company is trying to broaden its reach beyond smartphones into cars, data centers, Internet of Things devices, and even personal computers.

In fact, Qualcomm announced that it would acquire fellow chipmaker NXP Semiconductors to accelerate its chip diversification efforts, but the deal still hasn't been approved by Chinese regulators. Qualcomm has indicated that if this $44 billion acquisition doesn't close, it hopes to use the money that it would have spent on NXP Semiconductors on a large share repurchase, which would boost earnings per share.

A good plan, but uncertainty looms

Qualcomm's plan seems reasonable. It intends to double down on its core smartphone chip business, diversify its chip business into new markets, and address the severe issues with its wireless technology licensing business.

Ultimately, Qualcomm expects its efforts to yield between $6.75 and $7.50 in non-GAAP earnings per share during fiscal year 2019, up from $4.28 during fiscal year 2017. As of this writing, Qualcomm stock trades at $54.73 per share, or 12.79 times fiscal 2017 earnings. If Qualcomm can simply maintain its current multiple but grow its earnings per share to somewhere within its target range, then the stock could be worth between $86 per share and $95.93 per share. Even at the low end of that range, and even assuming no earnings multiple expansion, Qualcomm's stock would be worth more than the $82 that Broadcom offered.

Unfortunately, Qualcomm's plan depends significantly on factors outside of its control. It's not clear yet whether Qualcomm will be able to close the deal to acquire NXP, and there's plenty of uncertainty about how the legal battle with Apple and the other, unnamed smartphone maker will play out, as well as the impact that an unfavorable outcome would have on Qualcomm's business performance.

Nevertheless, the overall strategy seems to be reasonable, although it'll take time to play out, which could wear investors' patience even thinner than the last few years of drama have. But if Qualcomm is successful, the stock could potentially more than double from here.

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Ashraf Eassa owns shares of Qualcomm. The Motley Fool owns shares of and recommends Apple. The Motley Fool owns shares of Qualcomm and has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool recommends Broadcom Ltd and NXP Semiconductors. The Motley Fool has a disclosure policy.