I keep coming back to this post on the state of TV as we evaluate investing in content creators, potential industry consolidation, the risks of cord cutting and changing to subscription models. The Changing – And Unchanging – Structure of TV (Stratechery)
John Malone is thinking about consolidation amongst the content creators too. (WSJ)
Activist hedge fund JANA partners is targeting Qualcomm (QCOM). We do not agree that Qualcomm should be split up but we do agree that Qualcomm is undervalued.
He then went on to explain how the chip-making arm, QCT, is undervalued relative to the licensing part, QTL,
You look at valuation here. This company’s multiple has de-rated by 30% in last three years while the Nasdaq up 40%. At a market multiple for the licensing business — which has 87% margins, and $6 billion of Ebit — that leaves you the chip business with a negative valuation. Obviously, it’s not worth a negative value; it has tremendous strategic value. We think they need to figure out what they can do to close that valuation gap.
Qualcomm’s recent announcement of a $10 billion share repurchase program is a step in the right direction but JANA wants it done quicker and at a higher amount.
But this company stood out among companies, with 30% of its market cap sitting in cash. They haven’t spent the money yet. The $15 billion is the right amount, but they need to accelerate it, and they need to do it before the value-creation steps we are outlining.
And this is probably all that will come of this “activism”. Qualcomm’s licensing business is derived from its chip business and separating the two doesn’t make that much sense. Qualcomm does have a lot of cash and the licensing business continues to generate even more, so a bigger capital return plan could be done.
Qualcomm’s management has stated that they intend to grow their dividend faster than earnings for the next year or so. Keeping to that promise, Qualcomm raised its dividend by 14% on Monday and announced a new $10 billion stock buyback. $10 billion is 8.6% of Qualcomm’s current market cap.
“It’s a much bigger return of capital than usual,” said Mike Green, a fund manager at American Money Management LLC. which owns the stock. “The buyback was gigantic.”
Management has stated that they intend to return 75% of all free cash flow back to shareholders but this capital return program is different. Qualcomm will access the debt market to fund this capital return program because of the issues in repatriating its foreign held cash. This is what Apple (AAPL) has been doing.
This is from the AMM Dividend Letter released December 31, 2013. If you want to see the latest “Dividend Stock in Focus” as soon as it’s released then join our mailing listhere.
Dividend Stock in Focus
Qualcomm (QCOM): $74.25*
Qualcomm was founded in San Diego in 1985 by former UC San Diego Professor and MIT alumnus Irwin M. Jacobs along with 7 others.
The majority of Qualcomm’s revenue comes from the design of computer chips for cell phones and tablets. Open up any smartphone today and you are more than likely to see a Qualcomm based processing chip. In fact, Qualcomm is the sole chip supplier for Apple Inc.’s iPhones and iPads.
While Qualcomm’s lead position in mobile chipset design makes it the premier mobile chip company in the world, even more attractive in our view is the company’s network licensing business. Interestingly, this is a business built off of a technology first thought up of by one of Hollywood’s most attractive people.
Old Hollywood’s Role in Today’s Wireless Networks:
Hedy Lamarr was a contract star for MGM through the 1930s and 1940s and was considered one of the most beautiful people of her time. Hedy is probably most remembered for her then extremely controversial role in the 1933 movie “Ecstasy”, a movie with brief nude scenes of Ms. Lamarr and close up shots of Hedy’s face during a sex scene. While tame by today’s standards the movie caused a big controversy at the time.
Ms. Lamarr was much more than a pretty face, and should really be remembered for her contribution to modern communication. In 1942 she and composer George Antheil were granted a patent for frequency hopping. In the early 1940s torpedoes operated on one frequency and could very easily be jammed with overwhelming interference at the right frequency. George’s and Hedy’s technology based on the 88 keys of a piano would have the torpedoes hop between 88 frequencies avoiding the interference. Frequency hopping could prevent Allied torpedoes from being jammed. Well… it would have if the U.S. Navy didn’t sit on the technology until 1960.
Hedy and George’s technology would eventually become the basis for today’s wireless communication. Qualcomm’s CDMA technology, the backbone of today’s 3G wireless networks, is based on Hedy Lamarr’s original frequency hopping.
The companies that make the hardware for 3G and 4G wireless networks and the companies that own the wireless networks all use Qualcomm’s designs and all of them pay Qualcomm royalty fees (~ 3-5% on almost every smartphone sold globally), essentially making them a toll booth to the global 3G wireless network.
Qualcomm may at first appear to be an odd choice for a portfolio focused on dividends. While the current dividend yield is only 1.9%, Qualcomm has aggressively grown its annual dividend payout over the last 10 years from $0.19 per share to $1.20 for a compound annual growth rate of more than 20%. We expect Qualcomm to continue its policy of high dividend growth well into the future.
Catalysts for Dividend Growth and Price Appreciation:
3G & 4G Wireless network Growth:
While the U.S. and other developed countries are moving onto 4th generation markets the rest of the world is still connecting through 2nd generation networks. 80% of connections in China, and 90% in India are still 2G**. The growth in 3G connected devices in these developing markets over the next few years will be huge. From GSMA Intelligence:
3G and 4G technologies will account for half of all global mobile connections in five years, according to Wireless Intelligence forecasts.
We calculate that 3G/4G connections combined will account for about 4.25 billion of the 8.5 billion connections forecast by 2017, or 50 percent (40 percent 3G + 10 percent 4G). This is up from a combined 1.7 billion of the 6.5 billion total this year (26 percent).
In their recent analyst day Qualcomm said that they expect around 3.4 billion 3G/4G connections by 2017. Qualcomm stands to collect a lot of royalty payments as the rest of the world migrates from 2G to 3G.
Even as the more developed markets like the U.S. move onto the 4th generation wireless networks, the newest 4G smartphones will still need to be backwards compatible with 3G networks. The highest estimate for 4G connected devices by 2017 is 10%.
4G networks are still in the early stages of their development and there is a wide array of standards for it unlike the 3G network. It is a safe bet that Qualcomm will be a leader in 4G too. According to Barron’s, Qualcomm has a 3 year lead over its competitors when it comes to the 4G-LTE network.
The top two patent holders for 4G-LTE networks are Samsung with 9.36% of all patents and Qualcomm with 5.65%. Qualcomm also has the greater share of seminal 4G-LTE patents.
Of those seminal patents Qualcomm holds ~10% of the patents related to network coverage and key patents in the categories that are essential to better and smoother inter-network transition.
Return of Capital:
Since FY 2003 Qualcomm has returned over $26 billion to its shareholders in the form of increased dividends and share buybacks. In fiscal year 2013 alone, Qualcomm bought back over $4.6 billion worth of stock reducing shares outstanding by 4%***.
Paul Jacobs, the current CEO of Qualcomm, recently announced that going forward the company will return 75% of its free cash flow and increase the dividend by more than its earnings growth. Qualcomm is expected to grow its earnings over 10% in 2014. With almost $8 per share in cash on it balance sheet, Qualcomm has the ability to conduct further share buybacks.
Qualcomm is the toll booth to the 3G wireless data super highway right as the 3G network is about to explode with increased traffic. We would expect Qualcomm’s free cash flow to grow right along with it allowing for increased dividends and share buybacks. We estimate QCOM’s fair value at $95 per share, approximately 30% above the current share price.
* Price as of the close December 31, 2013 ** GSMA Intelligence *** Barron’s
The opinions expressed in “The AMM Dividend Letter” are those of Gabriel Wisdom, Michael Moore and Glenn Busch and do not necessarily reflect the opinions of American Money Management, LLC (AMM), an SEC registered investment advisor who serves as a portfolio manager to private accounts as well as to mutual funds. Clients of AMM, Mr. Wisdom, Mr. Moore, Mr. Busch, employees of AMM, and mutual funds AMM manages may buy or sell investments mentioned without prior notice. This newsletter should not be considered investment advice and is for educational purposes only. The opinions expressed do not constitute a recommendation to buy or sell securities. Investing involves risks, and you should consult your own investment advisor, attorney, or accountant before investing in anything. Current stock quotes are obtained at http://finance.yahoo.com. Prices are as of the close of the market on the date for which the price is referenced.