How To Buy Qualcomm With No Money Down

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Feb 25, 2015
  • The world needs Qualcomm’s products and services to continue our progression toward a wireless existence.
  • Qualcomm has built an absolute fortress of a balance sheet which provides an excellent margin of safety.
  • Accusations on monopolistic practices by China and transitioning from a growth stock to a value stock have stunted share price growth.
  • A way to own Qualcomm that you have probably never considered shows the real value it contains.

Qualcomm (QCOM, Financial) is best known for its code division multiple access (CDMA) technology which allows several transmitters to send information simultaneously over a single communication channel without interfering with each other. This allows multiple users to share a band of frequencies and increases the number of communications that can be conducted at the same time in a limited amount of bandwidth. Without this advancement in communications technology, our transition to a wireless existence would be severely restricted. If you use wireless communications devices, you probably own Qualcomm products or products where the manufacturer has paid a licensing fee to Qualcomm for using their technology. Once again, here is a business that provides a product or technology without which our society does not continue to function in the same manner as it does today.

The company operates through three business units operating as Qualcomm CDMA Technologies, Qualcomm Technology Licensing and Qualcomm Strategic Initiatives. The first of these operating units develops and supplies integrated circuits and software based on the company’s CDMA (code division multiple access) and orthogonal frequency division multiple access (OFDMA) technologies. It also oversees the company’s other technologies and products used in networking, application processing, multimedia, global positioning systems and voice and data communications. The Technology Licensing Group sells and leases the usage rights to Qualcomm’s technology and intellectual property to businesses, such as cell phone manufacturers and service providers who need this technology to make their products functional and competitive in the marketplace. These products and technologies include Qualcomm’s CDMA2000, WCDMA, CDMA TDD and OFDMA standards and their derivatives. Finally, the Strategic Initiatives segment invests in early-stage technology businesses that support the design and introduction of new products and services that could be complimentary to Qualcomm’s existing technologies and product offerings. It also holds a wireless spectrum license for the parent company. The company plans to increase its focus on wearable devices and technologies and technologies based on micro-electro-mechanical-systems structure for portable multiple multimedia devices and Wi-Fi products designed for implementation of small mobile base stations.

So, in Qualcomm, we have a business that owns the technology that makes mass wireless communications possible on a broad scale. It is not only marketing its own products using that technology but is also actively licensing it out to other users who need it for their own products. It is also investing in new, emerging technologies through its Strategic Initiatives division and this allows the company to keep itself on the leading edge of exciting new opportunities with market changing potential.

Ownership of proprietary products or technology of products that are necessary to our society or way of life and a focus on developing and investing in new technologies that will keep it on the leading edge are two of the key characteristics I look for in buy and hold investments and Qualcomm certainly fits the bill in regard to that criteria.

Necessity is nice but safety is rule #1

Businesses that provide proprietary products and services required by our way of life might be my favorite type of business, but rule #1 of investing is: “Do not lose money.” We all know it is going to happen from time to time, but my top priority in making investment decisions is to minimize the risk of it happening. Therefore, once I establish an interest in the products and services provided by the business, I immediately head for the financials of the business.

In the case of Qualcomm, it was a worthwhile exercise. We often hear people speak of businesses with a “fortress-like balance sheet” and I can only surmise they must have been looking at Qualcomm’s as well. Qualcomm’s recently released financial results for the first quarter of their fiscal year ending September 30, 2015, reveals some interesting facts about the financial health of the business. The company reported that it is holding cash and short-term investments of $17.788 billion. The current market capitalization of the business is approximately $117.98 billion. This means Qualcomm is holding about 15% of its total market value in cash and cash equivalents!

In addition to this cash hoard, the company has an additional $3.4 billion of accounts receivable and inventory. I don’t normally assign a great deal of value to inventory and accounts receivable as it is simply not realistic to expect to operate a business without those items. The major exception to that would be if the values were to be excessively high; but that is not an issue in this case so I simply ignore them. They are not large enough to pose any legitimate risk to the business and, at 12.8% of revenue, the amounts are sized to produce 8 turns a year which is quite attractive for a business of this size.

Not only does the balance provide us with an exceptional margin of safety and stability, the company is generating a stream of earnings on an upward trajectory. For the year ending September 30, 2015, the 33 analysts covering the stock have a consensus estimate of $4.98/share with the expectation that those earnings will increase by 7% to $5.33 in 2016.

EPS Trends Current Qtr.
Mar 15
Next Qtr.
Jun 15
Current Year
Sep 15
Next Year
Sep 16
Current Estimate 1.33 1.14 4.98 5.33
7 Days Ago 1.33 1.14 4.98 5.33
30 Days Ago 1.28 1.30 5.21 5.73
60 Days Ago 1.28 1.29 5.21 5.74
90 Days Ago 1.28 1.29 5.22 5.75

With a current share price of $71.52, the estimate for 2015 earnings produces a current P/E ratio of 14.36 compared to the average for the overall S&P 500 of 19.92. Qualcomm shares would have to rise by 38.7% simply to trade at the same valuation level as the broad market. Considering the way its products are woven into the fabric of our wireless lives, this huge discount to the broad market valuation should either provide new investors with excellent upside potential or substantial downside protection should QCOM become valued on par with the broad market.

The creation of opportunity

There are those times when something that seems like a negative can create huge opportunities. I believe that to be the case with Qualcomm. We have all watched over the past several years as technology titans have made the painful transitions from growth stock darlings to true value based businesses poised for long-term, stable growth in value and returns to investors.

Qualcomm is currently undergoing that type of transition and seems to be doing it very successfully. However, the market has always punished the share prices of business during these transitions and Qualcomm has been no exception. Earnings have grown at an annualized pace of 17.9% over the past five years but are projected to slow to 10.5% over the next five years. However, a 10.5% rate of earnings growth is quite respectable for a business this size and the market appears to be focused on the negative rather than the positive.

Every so often, a government will take an action that is designed to have a negative impact but simply serves to create an opportunity. There are times when a critical comment can actually be a compliment when the source is considered. Qualcomm was recently accused of engaging in monopolistic business practices ... by the communist government of China. Lots of businesses get accused of monopolistic practices; but, when it is done by a communist government, well, that is what one could most accurately describe as the height of professional recognition. The market, however, almost always tends to overreact to this type of situation and the resulting panicked selling creates opportunity for those able to take the long-term view. Just think back to the Mexican bribery scandal faced by Walmart (WMT, Financial) a few years ago that briefly pushed the share price of the world’s largest retailer down into the middle $40’s and created a spectacular short-term and long-term opportunity for investors who were willing to overlook a short-term, solvable problem.

The value of Qualcomm today

Qualcomm’s 10-Q SEC filing for the first quarter of 2014, ending December 31, 2014, Qualcomm reported earnings/share based upon GAAP (Generally Accepted Accounting Principles of $1.17/share and “adjusted earnings” of $1.34/share. The first quarter’s adjusted earnings exceeded the expectations of the analysts covering the stock for the fourth time in the last five quarters. This indicates that the company does a good job of managing expectations and avoiding ugly surprises.

As has already been discussed, Qualcomm’s shares would have to rise by 38.7% in order to trade at a P/E valuation equal to the S&P 500. For me, it would be hard to argue that this business is not worth at least as much as the average large business in this index. But, Qualcomm is not only cheap compared to the S&P 500 valuation, it is also trading at the low end of its own historic range of P/E multiple as shown in the chart below.

03May20171144401493829880.png

By also including the revenue levels in this chart we are able to see that revenue growth has continued at a pace that would seem to justify a valuation in line with the historic median P/E of the stock. Instead, we can see the shares are trading at the very low end of the historic range of valuation. If the stock were to return to its historic median valuation based on the P/E ratio, which I do not see as the likely outcome, the share price would soar to $137.50, or 92.52% above its current level. While I do not perceive this to be the most likely outcome, I certainly do not rule out that a case can be made for it being a realistic possibility as a “best case scenario.”

A much more conservative valuation of the business would price the stock in line with the broad average of the S&P at 19.92 times earnings. This results in a fair value estimate of the business of $99.20/share. But there is no guarantee that the market will decide to price this business according to its true intrinsic value any time soon, if ever.

Because we can never know when the real value of an overlooked, undervalued business will be recognized by the market, we always need to consider a very conservative case where the overall valuation remains the same, and our prospects for gain are limited to only the future value added to the business through its earnings growth and dividends. Once again, this metric also delivers good news for new investors looking for exceptional returns over extended periods.

Qualcomm is expected to expand its earnings at 10.5% over the next five years. This would represent a fall of 41% from the 17.9% annual growth rate the company has experienced over the last 5 years. A reduction of this size in the forward growth estimate should be indicative of it being a conservative estimate unless there is some permanent impairment to the future prospects of the business. That does not appear to be a major concern with Qualcomm. Therefore, we should be able to safely assume that using this metric will provide us with a very conservative method of calculating our expected returns in the future.

The forward growth rate of 10.5% should result in an equal increase in the stock price simply to maintain the current level of valuation. In addition to this increase, shareholders will also receive the quarterly dividend payments that have produced a total of $1.68/share (2.35% yield) over the past 4 quarters. But, Qualcomm has built up quite an impressive track record of increasing its dividend payments and those payments have risen at an annualized rate of 16.8% over the past 10 years. Not only is this business providing a steady stream of income through its dividend payments, it is giving its shareholders very impressive raises every year. It is always nice to have management teams that seem to realize the shareholders are the owners and need to be cared for and rewarded for the allocation of our capital.

If we simply assume the share price will rise at the same pace as the projected earnings growth rate of 10.5% and add the additional income from the 2.35% dividend yield, even conservative investors should be able to expect to earn a combined return of 12.85%/year by holding these shares.

The best way to buy Qualcomm

At today’s prices, Qualcomm appears to be cheap by just about any mode of comparison we select. But, there is one way to acquire ownership in Qualcomm that you have probably never even considered even though it would, quite likely, be the best way to buy it ... buy it all.

Now, before you dismiss this out of hand, hear me out. We have a business with a total market value of $118 billion. The company has $17.788 billion in cash and short-term investments on hand. If we wanted to purchase the entire business, $8 billion of the cash could be used as the down payment, leaving a balance of $110 billion required for the transaction. A recent sale of long term bonds by Microsoft (MSFT, Financial) resulted in a yield at 153 basis points above the rate for 30-year Treasury Bonds. Based on the current yield of 2.71% on the 30-year bond, an offering from Qualcomm that produced the same result would create a cost of financing equal to 4.24%. Just to be conservative, we will assume the debt would require a yield of 5%.

A 5% interest rate against $110 billion worth of bonds would require $5.5 billion/year to service the interest on the debt. Over the past 12 months, Qualcomm generated free cash flow of $7.24 billion. A new owner could service the interest on the debt and still have $1.74 billion left over for a nice compensation package. And, don’t forget the $9.788 billion left over in the existing cash balance after we took out our down payment.

Final thoughts and actionable conclusions

I understand that this is not a realistic proposal but it does serve to exemplify the absurdly low value the market is currently assigning to this business. The existing forward projections appear conservative compared to past performance and the business has products that are certainly critical to our march toward an increasingly wireless world.

However you view it, Qualcomm offers the potential for exceptional returns over the next 5 years and is currently valued at a level that offers both tremendous upside potential for capital gains as well as substantial protection for the downside since it is now valued at such a large discount to the overall market.

Those investors who find this proposal interesting but would prefer to acquire their shares at a bit of a discount to the current price may wish to consider selling the March 20, 2015 expiration put options with a strike price of $70. These option contracts can currently be sold for about $0.94/share and each contract represents 100 shares of the stock. Therefore, for each contract sold, the seller would receive $94 and take the obligation, but not the right, to purchase the shares at $70 each at any time between the sale of the contract and the expiration on March 20. The premium received of $94 represents an immediate return of 1.34% on the $7,000 that would be required to purchase 100 shares of the stock at the$70 strike price. Executing this trade 12 times over the course of a year would result in an annualized rate of return on your capital of 16.11% without ever owning the stock; not a bad return on capital in exchange for waiting to buy at a discount. The $70 strike price also represents a discount of 2.13% to the current share price.

Investors who like the stock at the current price but are looking for a way to enhance the return can consider buying the stock at the current price of $71.52 and selling covered call options against the position. For each 100 shares of the stock purchased, one covered call option with a strike price of $75 and an expiration date of March 20, 2015 can be sold. Buyers of this option contract are currently offering $0.24/share or $24/contract for this trade. This contract gives you the obligation, but not the right, to sell 100 shares of Qualcomm stock for $75/share at any time between the sale of the option and March 20. The premium received for selling this contract produces an immediate return on the $7,152 required to purchase the shares at the current price of 0.34%. If executed each month for a year, this transaction would produce an additional return of 4.03% on your allocated capital, in addition to the existing 2.35% dividend yield. Unless the stock were to rise 4.86% in the coming month, these options would expire worthless and the shareholder would be free to selling another set of call options against their shares for the following month out; possibly at an even higher strike price. In the worse case scenario, the stock will rise above $75 during the coming month and the shares would be called away leaving the investor with about a 5% gain in one month.