Qualcomm Is Healthier Than Hedge Fund Thinks
This week the hedge fund Jana Partners revealed a big position in Qualcomm and urged the company to break up, cut costs, buy back shares and replace a few directors -- the standard playbook for activist shareholders. But Qualcomm, the world’s leading mobile chipmaker, isn’t quite the typical activist target. And Jana’s proposals seemed to miss the mark.
Qualcomm has lagged the Nasdaq and the S&P 500 over the past five years, but when measured against its mobile chip competitors Intel and MediaTek, it’s not doing so badly. Qualcomm stock gained about 80 percent over the last five years, versus 32 percent and -25 percent for Intel and MediaTek, respectively.
Qualcomm has $7.9 billion in cash on the books, a tempting amount for activist shareholders who like finding big cash hoards and distributing the money to shareholders. Intel has $2.6 billion in cash and has underperformed the market by a wider margin than Qualcomm. And Intel chips are closely tied to PCs, sales of which continue to fall.
Qualcomm has also seen its fortunes improve in China, where it recently settled an anti-trust lawsuit. The deal included a $975 million fine and an agreement to charge lower royalty fees, but it also lets the company continue to sell its technology in the Chinese market. It was the specter of not being able to sell at all in the world’s largest smartphone market that had been the biggest worry for investors.
Plus, the company has already announced a $15 billion stock buyback, $10 billion of which is earmarked for the next year. (The Wall Street Journal reports that Qualcomm has paid out $37 billion in dividends and share buybacks since 2003, more than most of its peers. Dividends per share have increased, on average by 12 percent a year since 2011.)
Given all that, it's hard to make sense of Jana’s long list of proposed changes. It does seem that the market has undervalued Qualcomm, but the hedge fund’s proposals could keep the company from adjusting to the rapidly changing mobile market.
The market hasn’t taken to Jana’s proposals, either. When activists take aim at companies, their stocks often rise, as has been the case with Netflix, eBay and Yahoo. But Qualcomm stock actually dipped after the Jana news broke and today it’s up less than 1 percent.
There are two ways to look at Qualcomm -- as a smartphone chip leader that’s facing competitive headwinds and as a proxy for the growth of the smartphone market overall. Qualcomm's position in both areas is slipping, but accelerating its buyback and adding other stock boosting measures won’t solve those problems.
Qualcomm still dominates the mobile phone chip market, although competitors have eaten away at the company’s commanding lead. For example, the research firm Strategy Analytics says the company had about 80 percent of the LTE baseband processor sector in the third quarter of 2014, down from 95 percent in the third quarter of 2013. It also faces increasing competition from Samsung, which has long used Qualcomm chips. Now the Korean hardware company is using more of its own components as part of a massive turnaround effort. An analyst at FBR recently downgraded the stock because of Samsung.
The mobile market is also slowing down. Analysis from Bloomberg Intelligence says that chipmakers will be hit by “slowing smartphone sales growth” this year and that falling prices for smartphones overall will pressure prices for components such as chips. There are still a lot of 2G phones in Asia that need an upgrade, but the overall smartphone business could soon become significantly less lucrative. So Qualcomm needs to get into the market for wearable and other Internet connected devices in order to stay relevant.
But connected appliances and smart watches probably won’t destroy the smartphone market in the same way that smartphones hammered the PC market. If Apple is any indication, wearables and other devices will still depend on smartphone ownership and good connectivity. Qualcomm would be wise to try to remain a leader in the phone space.
Qualcomm can continue with its existing big buyback program and continue to pay out dividends. But to meet its twin challenges, it should be coming up with a plan to reinvest money in research and development, or maybe even make strategic acquisitions to get new technologies and expertise as devices get smaller and energy needs grow. It doesn’t need to slash and burn. It needs to invest in itself.
(Corrects comparison of Qualcomm to S&P 500 in second paragraph; the company has not outperformed the index over the past five years. Corrects sentence in eighth paragraph about Jana Partners' buyback proposal; the hedge fund wants to speed up an announced $15 billion plan, not spend more money on it. An earlier version of this column corrected the third paragraph to reflect that Intel's cash holdings are $2.6 billion, an amount that's less than Qualcomm's.)
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