Taking an old school approach to tech investing
By International Adviser, 25 Jul 18
Technology is undoubtedly today’s most discussed investment sector, with the high-profile FAANGs front and centre of most conversations. But it is important to recognise the opportunities within the diverse tech sector run far deeper, says Jacob Mitchell, portfolio manager and chief investment officer of Antipodes Partners.
Qualcomm invented many of the technologies at the heart of the communications revolution over the past 25 years.
It operates as two businesses – licensing and technologies.
Apple court case
Licensing generates revenue by charging device manufacturers for the use of Qualcomm’s intellectual property. This is typically a stable, high-margin business.
However, Qualcomm and Apple’s relationship soured in 2017, to the point where Apple began to withhold licensing payments. Apple’s decision caused a steep decline in revenues in Qualcomm licensing, as well as higher legal costs to protect its IP position.
While we do not have specific insights into how a court might ultimately adjudicate, we would be surprised if any court could determine Apple should somehow be treated differently from others in the industry. A commercial agreement is likely to be reached, which would restart Apple’s payments and provide a one-time payment for withheld royalties.
Mobile phones
Qualcomm’s technologies business supplies chips to power mobile devices.
This business has the leading market position in a highly consolidated industry with extremely high and growing entry barriers.
Intel has just been scrapped as a modem supplier from the 2020 iphone and the other two leading players, Mediatek and Samsung, are still behind on performance innovation, as evidenced by the fact Samsung still uses Qualcomm’s products in the high-performance Galaxy range of smartphones.
Room to grow
Qualcomm has been historically undermanaged, with margins significantly below what we believe achievable given its scale. Semiconductor peers with similar dominance routinely generate operating margins above 20%, versus Qualcomm’s more recent levels in the mid-teens.
In addition, Qualcomm should take control of the world’s leading supplier of semiconductors to the automotive market (NXP Semiconductor) later this year, where we see tremendous synergies with its existing prowess in communications meeting the demand of the next generation of connected vehicles.
Further evidence of Qualcomm’s portfolio and industry position were provided last year, when rival semiconductor company Broadcom unsuccessfully bid for the company.
Potential
We see multiple ways to win over the next three years – including a successful integration of NXP, settlement of outstanding disputes with Apple and the initial ramp of 5G technologies, where Qualcomm should naturally lead, as well as a much sharper focus on margins and return on capital driven by the scare Broadcom provided.
Qualcomm’s natural cash generation affords the company a near 5% dividend yield, a rarity for tech companies, while we ultimately believe the uncertainties weighing on the shares will be resolved by early 2019.
At this point the market is likely to embrace Qualcomm’s true earnings power, with its share price potential above $90 (£69, €77) a share.
Tags: FAANG | Investment Strategy
