Key Risks
With such a great business benefiting from these strong secular trends and secured by a strong intellectual property portfolio, many investors are wondering why the shares of the company have declined so precipitously.
As noted above, Qualcomm makes most of their profits in the licensing business. However, over the last year or two there have been some negative developments.
The two main issues are declining royalty rates and a weaker intellectual property portfolio for newer wireless technology generations.
Some companies and entities have proposed changes to intellectual property policies with the goal of devaluing Qualcomm’s patents and breaking up its hold on mobile devices.
For instance, in China they reached a resolution with the National Development and Reform Commission (NDRC) where they will charge royalties of 5% for multimode 3G/4G devices but only 3.5% for 4G.
Furthermore, the royalty rates will be based off 65% of the device’s net selling price instead of the full price.
This is a big change in the way Qualcomm has historically generated royalty revenue in China and effectively results in a cut in royalty rates for 3G to 3.25% (5% x 65%) and 4G to 2.275% (3.5% x 65%).
While the percentages might sound small, the differences really add up when applied over millions of units.
Also, many of their key customers have been lobbying standards groups (2) to change their policies away from Qualcomm’s current licensing and royalty structure with the aim of lowering royalty rates.
One of the main contributing factors to the lower rate is that their intellectual property portfolio isn’t as strong in subsequent generations (4G/5G) as it is in 3G.
3G/4G multimode products are generally covered by their existing 3G licensing agreement, but products that implement 4G and not also 3G are not generally covered by these agreements, so their overall royalty rate for 4G is lower than 3G.
These are real issues for the company and given global politics and competitive positions, they are very difficult issues for investors to obtain clarity.
To offset some of these issues management has been executing on a strategic realignment plan that calls for a spending reduction of $1.4 billion. Reducing the cost structure should result in QCT operating margins improving to at least 20% (from 14% in 2015).
Time will tell if internal actions can offset some the negative trends the company faces in the industry, but for now it looks like Qualcomm’s entrenched business might be showing some cracks.
Dividend Safety Analysis: Qualcomm
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. Qualcomm’s dividend and fundamental data charts can all be seen by clicking here.
Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.
Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.
We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their track record has been, and how to use them for your portfolio here (4).
