Latest Xiaomi Deal Will Accelerate Qualcomm Stock's Rebound

  • Semiconductors giant Qualcomm is under investigation in the EU, the US, and South Korea.
  • A similar probe in China ended in Qualcomm paying almost a $1B fine.
  • Qualcomm signed a few agreements to streamline its licensing business in China.
  • New deals led by the Xiaomi deal will drive Qualcomm's revival in China.

The San Diego-based chipmaker Qualcomm (NASDAQ:QCOM) is having one of the hardest years ever in the history of the company. Fair trade commissions around the world investigate Qualcomm for illegally obtaining its smartphone market share by executing shady licensing practices in United States, European Union, and South Korea. Earlier this year, the company reached an agreement with the Chinese authorities to pay a $975M fine for violating the country’s anti-monopoly law after a two-year investigation.

Qualcomm stock price was severely impacted by the antitrust probes worldwide as investors were concerned that potential massive fines will erode the company’s bottom line and will force it to make fundamental changes to its patent licensing business. Qualcomm stock price has also been by the impacted the weakness in the semiconductors business, disappointing quarterly results and the decision to stop providing annual revenues and EPS guidance.

QCOM_chart 2_120915

To stop the price decline and even boost stock price, activist shareholder Jana Partners pressured Qualcomm to consider breaking up its patent licensing business (‘QTL’) from its chip business (‘QCT’) and boost stock buybacks to boost the stock price. One of Qualcomm’s biggest competitors in the mobile chip business, Intel (NASDAQ:INTC) was rumored to show interest in the QTL business in the case of a spin-off/sale – a deal that could have destroyed Qualcomm’s leadership position. Moreover, Intel was named a possible second LTE chip vendor for Apple’s next iPhone together with Qualcomm, which means that Qualcomm will lose market share and revenue in the following years to its biggest rival.

Qualcomm agreed to consider a QTL spin-off and accelerate the stock buyback program. However, its biggest problem was in the Chinese market. Qualcomm was heavily relying on sales to the rising Chinese vendors, and when they started withholding royalty payment to Qualcomm last year in light of the government inquiry, Qualcomm’s results were impacted. To get the Chinese revenues back on track and stabilize the company’s financial outlook, Qualcomm started negotiating new licensing agreements with the leading Chinese smartphone manufacturers.

As shown in the chart below, the three leading Chinese smartphone vendors, Xiaomi, Lenovo, and Huawei, have a combined worldwide market share of 17.5% and a combined China market share of 33.4%. These significant market shares make these local vendors an important piece of Qualcomm’s smartphone business in China and even more important in light of their presence in other consumer electronics markets like tablets, PCs, smartwatches, wearables, etc.

QCOM_chart 3_120915

Qualcomm signed a new licensing agreement with ZTE and TCL, who led the category in the chart above, and with Huawei, which dominated 7.7% of the global market and 11.4% of that of China, making it the fourth largest player in China and the third largest player in the world. Last week, Qualcomm signed the most significant agreement so far with the biggest local player in China, Xiaomi, which is the fifth largest player in the world and is the third largest in China. It is the leading consumer electronics vendor in China, selling smartphones, tablets, phablets, fitness trackers, portable chargers, smart TVs, headphones, and more.

After dominating the Chinese market, Xiaomi is believed to be the next worldwide consumer electronics giant slowly expanding abroad. The Xiaomi agreement, together with the ZTE, TCL, and Huawei deals, enable Qualcomm to leverage the China probe into strengthening its leadership position there. The purchasing deals for devices sold in Q1 were closed earlier this year, which means the recent agreement will only impact Qualcomm’s financials in late Q2 and the second half of 2016. Even though the EU, US, and South Korean investigations are not done yet, Qualcomm stock is positioned to bounce back, reviving its Chinese operations towards mid-2016.

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