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Why Qualcomm Ruled Out the Possibility of a Split

Paige Tanner

Qualcomm's Plan for 2016 after Its Bumpy 2015 Ride

(Continued from Prior Part)

Qualcomm rules out a split

As we’ve already seen, Qualcomm’s (QCOM) dominant position in the mobile chipset market is being threatened by competition from Chinese chip designers and customs chips from Samsung (SSNLF) and Apple (AAPL). Meanwhile, its licensing business is doing well despite several headwinds.

The contrasting nature of Qualcomm’s two businesses is limiting the company from adopting an ideal capital structure and delivering value to shareholders. As a result, activist investor JANA Partners has asked the company to split its chip and licensing businesses. On December 15, 2015, Qualcomm’s board of directors reviewed this option and ruled it out. The board stated that the current business structure is the best. Let’s look now at the positives and the negatives of a split.

Advantages of a split

QTL (Qualcomm Technology Licensing), Qualcomm’s licensing business, can support a heavy debt capital structure. It churns out recurring revenue and is less capital-intensive. But QCT (Qualcomm CDMA Technologies), Qualcomm’s chip business, requires a heavy equity capital structure since it involves huge capital expenditures with cyclical revenues.

Let’s compare Qualcomm with InterDigital, a pure-play licensing company. Qualcomm has a debt-to-equity ratio of 34.92. InterDigital has a ratio of 97.82. MediaTek, a pure-play mobile chip company, has a debt-to-equity ratio of 24.06. Splitting Qualcomm would enable the company to adopt an ideal capital structure for each business.

Disadvantages of a split

Qualcomm, however, can’t afford to split its businesses, given the synergies derived from the combination of the two subsidiaries. QCT, the chip business, accounts for a major portion of the company’s revenue and also bears all the R&D (research and development) expense. QTL, the licensing business, accounts for only 31% of the company’s revenue and can’t support the high R&D and legal costs in a licensing-only business model.

On the other hand, QCT accounts for only 26% of the profit. So the chip business is able to spend more on R&D due to higher profits from licensing. This interdependence of the two segments makes a split difficult, which is why Qualcomm ruled it out.

Alternatives to a split

Several Wall Street analysts have suggested two alternatives to a Qualcomm split:

  1. Qualcomm could avoid a split by partnering with Intel (INTC).

  2. Qualcomm could spin off the licensing business and merge the chip business with Intel.

We’ll explore the pros and cons of a merger or partnership with Intel in the next part of the series.

The Powershares QQQ ETF (QQQ) has more than 50% of its holding in large-cap information technology stocks. It has 1.4% exposure in QCOM.

Continue to Next Part

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