Taking A Closer Look At A Qualcomm, Inc. Split: BMO

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It was reported by several media outlets on Tuesday that knowledgeable sources were saying that mobile chip maker Qualcomm was likely to announce a “strategic review” in its upcoming earnings conference call on Wednesday. Analysts point out that activist hedge fund JANA Partners had been pressuring Qualcomm management to split up the firm’s chip manufacturing and licensing royalty units.

Research firm BMO Capital Markets published a report on July 21st examining the pros and cons of a split up of Qualcomm. BMO analyst Tim Long and colleagues suggest that the long-term value of splitting off the royalty division from the chip making unit is not clear, and management would have to make a compelling case to investors if it it did decide to move forward with the split.

Long et al. note: “We believe there is value to be unlocked by splitting the company into a chipset and a royalty company, particularly because QCOM stock is trading below peers, at 10x 2016 earnings (ex-cash) and has seen no multiple expansion over the past few years. However, we believe the company would need to find a way to keep some of the powerful synergies that exist today, namely pass through rights that benefit chips and R&D investment that aids the royalty

Qualcomm is a unique case

Qualcomm Split

The BMO analysts highlight that Qualcomm is unique case in the tech world. There are other companies such as Texas Instruments that make a lot of income from licensing their intellectual property, but practically none enjoy the multiple synergies that Qualcomm does.

They also explain the importance of the pass-through rights that products with Qualcomm chips enjoy. “We have long contended that one of the hidden values in QCOM’s chip business lies in its ability to provide pass through rights. In general, when a handset OEM buys a QCOM chip, that OEM gets a certain level of patent protection from other handset companies that have allowed QCOM to “pass though” their patents.”

Long and colleagues highlight the value of pass through rights in legal disputes. They argue that QCOM has strong competitive advantages in the chip business given scale, brand, providing CDMA and technology leadership. According to them, pass through rights are “another meaningful differentiator that has made it hard for companies like Intel, Broadcom (now gone from the market), and Marvel to compete.”

A recent example of the value of pass through rights can be seen in a legal dispute in India. An Indian court placed an injunction on smartphones made by Xiaomi as they did not have a licensing agreement with Ericsson. That said, Xiaomi phones that used QCOM chips could still be sold because of pass through rights.

Another consideration in undertaking to split up the company is that the majority of the firm’s patent creation stems from the chipset business. Long et al argue that a split up of Qualcomm reduce the creation of new patents in the royalty firm, unless there was a major change in the firm’s R&D development structure.

A final consideration is that splitting into two separate firms means two management teams, two separate IT systems, increased regulatory costs and more overhead expenses.

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