We have recently fielded a lot of negative sentiment about Qualcomm. As analysts, we were generally fairly favorable towards the company and have worked there as well, and so many on the Buy-side view us as being generally pro-Qualcomm. So when various fund managers discuss the company with us, they tend to approach the subject much as someone might tell a parent that their baby is ugly. And so over the past month when every one we spoke to on the Street about Qualcomm voice some flavor of negative sentiment we took notice. Now to be clear, we are not in the markets, and do not mean to convey that there is some sort of negative consensus about the stock, nonetheless, we were a bit surprised by this consistency.
In general, the critique of Qualcomm is that while the company is doing well, growth prospects are not exciting enough to help the stock attract a premium. Most investor recognize that Qualcomm is doing well in automotive, garnering a steady set of design wins. But those do not really start to convert into revenue until 2024, and probably do not move the needle much until 2025 at the earliest. No one on the Street looks out that far. IoT seems to be doing well, but most investors have long since abandoned building out IoT market models, too much fragmentation, and so they ascribe little value to the segment. PCs are too small and too new to merit any credit from the Street. RF is doing well, but is largely just more exposure to mobile phones, and mobile phones are not a great segment right now for anyone. Add to this the fact that it looks likely Qualcomm will start to lose its socket at Apple next year, and investors are left with little to get excited about.
A surprising number of investors feel pretty strongly that for Qualcomm to get interesting again, as a stock, they need to acquire somebody. In our view, this is a backwards looking approach to the company’s strategy. In the 2010’s it would have made a lot of sense for Qualcomm to buy one of its peers in order to add scale and diversify its end markets. But for the most part, that wave of consolidation is over, there are many reasons to think that semis companies in general, and Qualcomm in particular, can no longer rely on that old approach. Then add to that the very dubious state of regulatory approval for deals in China, and maybe in the US too. Many at Qualcomm still bear scars from the NXP acquisition about which to this day they have still not heard back from the Chinese government. Qualcomm has made it fairly clear that they are unlikely to do any large, transformative deals.
But just for the sake of argument, who could they buy? Put simply, there are not a lot of good targets left. Let’s just assume NXP is off the table. The analog companies would not make a good fit, their business models are just too divergent. When pushed on this, most investors end up pointing to Marvell. We are fans of Marvell, but there are very few adjacencies in the two companies’ businesses. This would be a deal just the sake of doing a deal.
And then one investor suggested they should buy Broadcom’s semiconductor business. The logic here is that Broadcom is now a software private equity company, with declining levels of interest in semis. Private equity companies all like to have exits, so maybe they part ways with their semiconductor portfolio, and go use the funds to buy Oracle or whoever. There is some business logic here as well. Broadcom has a critical wireless business around their RF filters, which could provide a huge boost to Qualcomm’s RF business, and possibly provide a way back into the iPhone. And the rest of the portfolio has some very lucrative networking and storage businesses, which would provide that diversification that everyone wants for Qualcomm.
So not a totally crazy idea, but there are a few problems.
First, Broadcom and Qualcomm are very close competitors in the market for connectivity chips (Wi-Fi, Bluetooth, GPS, etc.), and this likely fails all the anti-trust tests. So let’s assume Qualcomm agrees to divest that business.
Second, Broadcom CEO Hock Tan has spent the past twenty years cutting some of the best M&A deals in semis. Would you buy a company from this man and be able to sleep well the night after the deal closes?
The third, and largest problem is that Qualcomm can probably not afford the deal. Broadcom’s semis business did $26 billion in revenue in 2022. The sector is trading at roughly 6.00x 2023 revenue. Let’s say Broadcom’s semis do $29 billion in revenue this year, the would value the deal at $184 billion, which is higher than Qualcomm’s current enterprise value of $137 billion. That is already a stretch and we have not even factored in any deal premium.
As above, just for the sake of argument, let’s say Qualcomm could line up the financing. Qualcomm currently trades at 3.5x 2023 earnings, so buying Broadcom for 6.0x is going to be heavily dilutive. On the other hand, if Qualcomm uses all its cash ($8.2 billion) and sells off the connectivity business for $20 billion, they would need $156 billion in debt to finance the deal. The annual interest expense on that would be just about $11 billion. By comparison, Broadcom’s semis business probably generates around $9 billion a year in EBITDA. So Qualcomm would need to find $2 billion in synergies just to break even, and finding synergies in the most cost-conscious semis business in the world is not going to be easy, (Note: the $20 billion for the connectivity business and the EBITDA figure are just our very rough estimates, Broadcom does not break out much detail about its semis business anymore.)
Despite some serious strategic merits, there is no way this deal is plausible. In fact, it just shows how difficult it will be for Qualcomm to pursue a growth by acquisition strategy. Yes, there are smaller targets, but not that many. A better strategy is to grow organically with the occasional bolt-on deal to bolster some product or technology. That is probably not going to satisfy some people on the Street, but is probably the better long-term approach for the company to take.