Tech

Tara Lachapelle is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Shira Ovide is a Bloomberg Gadfly columnist covering technology. She previously was a reporter for the Wall Street Journal.

Though activist investors have lately spurred legions of companies to split up in the name of a higher stock price, breakups aren't always the best fit. Qualcomm is one company that may be better left intact.

The $70 billion computer-chip maker's management thinks so, at least. After reviewing different ways to reinvigorate a stock that has lost 38 percent this year, the company is leaning against a breakup, people familiar with the matter told Bloomberg News. A decision may be announced by the end of the week, according to the report.

Strategic Retreat
Qualcomm investors don't have high hopes for the strategic review, as evidenced by the falling stock price. Even a $15 billion share repurchase authorization hasn't helped.
Source: Bloomberg

Qualcomm's not exactly the sexiest name in tech, but its computer chips and wireless modems are essential components in many of the smartphones to which consumers are addicted. Talk of splitting up the company has been around for a while. But the idea started to gain traction in April -- even as much of the rest of the industry was turning to mergers. Investor Barry Rosenstein of Jana Partners said at a conference that month that Qualcomm should conduct a review to see whether a breakup would increase shareholder value. 

The rationale is pretty simple on its face: One unit makes the chips, and the other collects fees from smartphone makers that use Qualcomm’s patents. This patent-licensing business accounts for a minority of Qualcomm’s revenue but a majority of profits.

Integrated Circuits
Qualcomm has said its two operating businesses -- making mobile phone components and collecting patent fees -- feed off each other. Revenue from each operation for the fiscal years ended in September.
Source: Bloomberg data

But the two divisions are more intertwined than at first glance. The chip-making business has come under severe pressure as Samsung, a large customer, increasingly uses its own in-house components. So Qualcomm relies on the large amount of cash generated by its ultra-profitable licensing division to fund research and development for the chip unit. If successful, Qualcomm can come up with new patents. 

No doubt, the status quo isn't working well. The company is being hurt by two, somewhat contradictory forces: waning market share and scrutiny of its market power. It can’t hope to sustain what once was a near lock on the market for smartphone chips and wireless modems. It's losing Samsung orders, and Apple has never been a big buyer of the company's mobile components. On the cheaper end of the market, it's losing ground to Chinese rivals that make low-priced parts to connect phones to cellular networks. 

Feasting on Chips
While Qualcomm considers whether to break itself up, its rivals are on a merger spree.
Source: Bloomberg

At the same time, Qualcomm’s power over the chip market has attracted poking and prodding from regulators around the world, including in the U.S., South Korea, Taiwan and Europe. Qualcomm agreed earlier this year to pay $975 million to resolve an antitrust case in China. The long Chinese investigation gave cover to some domestic phone makers to skip patent payments they owed to Qualcomm. Bank of Montreal analysts last month estimated Chinese phone makers haven’t paid the patent fees on about half of the units they sell, and most of them likely will never pay. (The analysts issued their research note before Qualcomm announced a patent licensing pact with China's Xiaomi.)

As the company grapples with all this, it's simultaneously distracted by a strategic review that might not yield anything (except, maybe, a boost to its suffering bond prices). Meanwhile, it's sitting on about $31 billion of cash and equivalents -- 44 percent of its market value -- as peers take part in an unprecedented merger frenzy. About $104 billion worth of semiconductor deals have been announced this year, almost on par with the volume for the previous seven years combined. Some have even drawn bidding wars. 

Chief Executive Steve Mollenkopf said in July that Qualcomm was "very likely to be some form of actor" in the deal scramble but that the timing "is always the debate." The company's last purchase of size was in October 2014, when it paid about $2 billion for CSR of the U.K. 

The clock is ticking, though. When a company's stock is tumbling the way Qualcomm's has, financial engineering in the form of a breakup may seem like a quick-fix solution. But for Qualcomm, it doesn't solve the problem of competition or legal uncertainty. And it would also shut off the chip unit's access to cash generated by Qualcomm's patents. Qualcomm's better option is to move on from the breakup idea and instead consider using its cash hoard to join the industry M&A, lest it gets left behind. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the authors of this story:
Tara Lachapelle in New York at tlachapelle@bloomberg.net
Shira Ovide in New York at sovide@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net