- Qualcomm stock has been hit the hardest by the recent sanctions on ZTE by U.S. regulators.
- The short-term effect on Qualcomm stock is likely to be muted.
- The long-term effect could turn out to be worse if the Chinese Government decides to retaliate.
News of a U.S. export ban against Chinese low-end smartphone manufacturer ZTE seems to have slammed the brakes on a recent rally by Qualcomm (NASDAQ:QCOM) stock. Qualcomm stock price had rallied 24% from its February low before the investing world was jolted after regulators imposed trade sanctions on ZTE for allegedly using four shell companies to illegally re-export controlled items to Iran in direct violation of U.S. export control laws. Although ZTE can still sell its products in the U.S., the company cannot procure components from U.S. companies. Even though affected companies such as Qualcomm are free to re-apply for new export licenses, the default decision by the US Department of Commerce will be to deny those licenses.
ZTE is one of the world’s largest smartphone manufacturers, with an estimated 4% global smartphone market share. ZTE mainly competes against Samsung alongside the likes of Xiaomi and Huawei in the low-end to mid-range smartphones market. But how much business does ZTE do with U.S. smartphone component manufacturers? Turns out, quite a lot. Pacific Crest analyst John Vinh estimates that ZTE does business directly with no less than seven smartphone component manufacturers in the US. According to Vinh, FPGA manufacturer Xilinx (NASDAQ:XLNX) is the U.S. supplier most reliant on ZTE since it derives 3%-3.5% of its revenue from the company. Silicon Laboratories (NASDAQ:SLAB) is second with 2%-2.5% of its revenue coming from ZTE sales. Qualcomm, Qorvo (NASDAQ:QRVO), and IDT (NYSE:IDT), are in the middle of the pack with 2% of their revenue coming from ZTE. Cavium (NASDAQ:CAVM) and Skyworks Solutions (NASDAQ:SWKS) bring up the rear with 1.5% of their sales coming from the Chinese smartphone manufacturer.
The ZTE headwind for Qualcomm is therefore limited to ~2% of its revenue. While a 2% loss of revenue is by no means insignificant, Qualcomm might ironically be able to get away with it this time around. Qualcomm issued weak Q1 2016 guidance saying that it expects first quarter revenue of $4.9B-$5.7B against a consensus of $5.69B. During its latest earnings call, Qualcomm managed to beat consensus revenue estimate by $80M or about 1.4%. Assuming ZTE sales are spread out evenly during the year, then the revenue shortfall will be limited to ~0.5% of Qualcomm’s revenue. This implies that Qualcomm might still manage to top revenue estimates despite the ZTE fiasco.
Interestingly, Qualcomm stock has been hit the hardest by the ZTE ban compared with other supplier stocks. There is a good reason why this is the case. Although the short-term effect of the ban on Qualcomm’s outlook is likely to be muted, the long-term effect might not be so benign. Qualcomm signed a new 3G/4G mobile licensing deal with ZTE in November of 2015. The mobile chip technology company has lately been making good inroads into the Chinese mobile market by persuading manufacturers such as ZTE to come to the deal table. The Chinese government had been indirectly encouraging smartphone manufacturers in China not to pay royalties to Qualcomm by labeling its business practices in the country monopolistic. The ZTE ban can potentially reverse the gains Qualcomm has been making in the country if Beijing decides to retaliate with its own sanctions against U.S. firms.
The short-term effect of the ZTE sanctions on Qualcomm’s business is likely to remain muted. The long-term damage, however, could be significant if Beijing decides to retaliate with its own set of sanctions against US companies. Qualcomm might be negatively impacted over the long-term because such a move would strain its delicate ties with smartphone manufacturers in the Middle Kingdom.