A Broadcom Deal For Qualcomm Raises Some Big Questions

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Even for a company with an M&A history as prolific as Broadcom Ltd.’s (AVGO) , an unsolicited $100 billion plus-offer to buy Qualcomm Inc. (QCOM) — a company that’s trying to close a $47 billion deal to buy NXP Semiconductors NV (NXPI) — is pretty stunning.

Chances are that Broadcom is motivated to make such a bold move not only by the top and bottom-line benefits a deal could deliver — and they are quite substantial — but also by a recognition that time might be of the essence for such a bid. Both because of where Broadcom’s shares stand following a 50%-plus 2017 run-up, and where Qualcomm’s stand as worries about both the NXP deal’s closing and its patent-licensing disputes with Apple Inc. (AAPL) and others scare off risk-averse investors.

Multiple publications report Broadcom, which on Nov. 1 announced it would move its headquarters back to the U.S. from Singapore, is prepping a cash/stock offer for San Diego-based Qualcomm that would value the latter at around $70 per share — a 27% premium to Qualcomm’s Nov. 2 close. The Wall Street Journal states a massive 80% to 90% of the deal’s payout would consist of cash, and that the bid could be launched over the weekend.

In response, Qualcomm shares rose 12.7% on Friday, Nov. 3 to $61.81, a level that suggests a healthy amount of skepticism remains about Broadcom’s ability to pull off the deal. Broadcom, which was already making new highs in response to top customer Apple’s strong September quarter earnings report, added to its gains following the reports and closed up 5.5% to $273.63.

Separately, a few hours after Broadcom-Qualcomm reports emerged, the WSJ reported Marvell Technology Group (MRVL) , which competes against Broadcom in the connectivity chip and hard drive/SSD controller markets, is in talks to merge with Cavium Inc. (CAVM) , which competes with Broadcom in the network processor market. Naturally, shares of both companies popped on the news.

What makes Qualcomm such an appealing target to Broadcom, which is hardly in desperate need of another deal? We think the selling points fall into three categories:

Cost Synergies

Broadcom — known as Avago before it acquired Broadcom for $37 billion in early 2016 and took its name — has been nothing if not incredibly effective at wringing out cost savings from the many chip and component makers it has bought over the last several years. In the case of the old Broadcom, which did 2014 sales of $8.4 billion, the company set a goal of attaining $750 million in annual cost savings within 18 months of the deal’s closing.

Though Qualcomm’s chip division (QCT) carried out major layoffs last year, the new Broadcom likely sees more room to cut costs, in part by consolidating overlapping R&D and administrative functions. QCT posted fiscal 2017 (ended in September) sales of $15.4 billion.

Qualcomm CEO, Steve Mollenkopf.

Product Synergies and Negotiating Power

A Broadcom-Qualcomm merger would create a mobile chip colossus. Qualcomm is by far the world’s largest supplier of 3G/4G modems and system-on-chips that pair a modem with an app processor, and also sells a number of complementary parts. Broadcom is the top supplier Wi-Fi/Bluetooth combo chips for mobile devices, and is also a major supplier of RF chips and modules for high-end phones. It also supplies mobile OEMs with touchscreen controllers, NFC chips and — in the case of the iPhone 8 and X — wireless charging chips.

A deal could also have some data center synergies: Broadcom supplies OEMs and cloud giants with a variety of Ethernet, storage and optical chips and components, and Qualcomm is working to land design wins for its just-launched Centriq server CPU line. And should Qualcomm’s purchase of NXP — the largest player in a growing automotive chip market — close, there would be plenty of value in fusing NXP, Qualcomm and Broadcom’s automotive product lines.

In addition to giving Broadcom the chance to pitch OEMs on soup-to-nuts solutions (or something close to it), creating expanded product lines would give the post-merger company a lot of negotiating power with OEMs. Especially in mobile, where Apple and Samsung are known to drive hard bargains with suppliers.

Qualcomm and NXP’s Low Valuations

Though Qualcomm’s fiscal 2017 earnings hurt by decisions by Apple and another major licensee (possibly Samsung) to stop paying royalties on phone sales, net income still totaled $6.4 billion. And on average, analysts see NXP, which Qualcomm aims to purchase with the help of a $38 billion cash balance, delivering 2018 net income of $2.5 billion.

If Qualcomm can achieve even semi-favorable settlements for its licensing disputes and hit its goal of getting $500 million in NXP-related cost savings within two years of the deal’s closing, the combined company could easily see over $11 billion in profits. And Broadcom, of course, could obtain additional cost savings.

Put it all together, and a $70-per-share acquisition price might be equal to around 10 times Qualcomm/NXP’s earnings in a couple of years, after accounting for the net debt Qualcomm would have following the NXP deal’s closing. That’s quite the bargain, especially in the current valuation environment.

Qualcomm, of course, might feel the same way and demand a significantly higher price. But even if a deal is reached somewhere near $70 per share, there are still some massive question marks surrounding it. I think the largest are the following:

How Will Antitrust Regulators View the Deal?

Should a Broadcom/Qualcomm deal be inked, look for regulators in the U.S., EU and elsewhere to get an earful from mobile OEMs about the combined company’s market shares and pricing power. Broadcom and Qualcomm proper’s overlap in the combo chip market, and Broadcom and NXP’s overlap in the NFC chip market, are especially likely to get attention.

Would asset sales in such areas be enough to appease regulators? As far as American approval goes, Broadcom’s decision move its HQ to the U.S. might have just won it some goodwill.

How will Broadcom Handle the Qualcomm/Apple Dispute?

Given Apple is its biggest customer, it’s hard to believe that Broadcom would close a Qualcomm purchase without either having already settled Qualcomm’s bitter multi-billion dollar dispute with Apple over iPhone royalties, or at least positioned itself to quickly settle the matter post-closing. Especially since Apple is reportedly hatching plans to no longer use Qualcomm’s best-in-class 4G modems in future iPhones and iPads.

The various synergies a Qualcomm deal provides could motivate Broadcom to try and quickly put the issue to rest, even if it means giving Apple decent-sized royalty rate cuts. At the same time, Apple’s dependence on Broadcom, particularly on the RF side of things, could give Broadcom some negotiating leverage of its own.

Another possibility: Broadcom chooses to spin off or sell Qualcomm’s very profitable licensing business to rid itself of the Apple dispute and make an acquisition easier to finance. But given the issues the business currently faces, it would be selling low. Moreover, Qualcomm’s chip and licensing divisions lean on each other in various ways.

Qualcomm has been battling Apple. A Broadcom Deal For Qualcomm Raises Some Big Questions 88871692 bd7f 11e7 bc3b 01a676c2d4df
Qualcomm has been battling Apple.

Will Broadcom Still Pursue the NXP deal? And If So, What Price Is It Willing to Offer Disgruntled Investors?

Assuming Broadcom (current market cap of $111 billion) wants to hold onto Qualcomm’s licensing business and buy NXP, the total bill for a Qualcomm deal at a $70-per-share price would be around $120 billion after accounting for net debt. It’s tough to imagine Broadcom being able to finance 80% to 90% of this price via cash.

If Broadcom chose to take NXP out of the equation, it would remove at least $47 billion from the deal price. And quite possibly more — many NXP investors want Qualcomm to up its $110-per-share buyout price, and only a tiny fraction of the 80% of NXP shares that need to be tendered for the deal to close are currently tendered.

Also: Integrating Qualcomm by itself would require a ton of work on Broadcom’s part. Simultaneously having to integrate NXP might be too much for even Broadcom’s management to handle.

NXP went into Nov. 3 trading above $117 due to expectations Qualcomm will eventually hike its offer. But shares fell 2.1% to $115.02 on fears that Broadcom (should it ink a deal to buy Qualcomm) would choose to walk away from NXP. Reuters reports Broadcom is open to also buying NXP, but doesn’t provide specifics.

We might get a bit of clarity regarding questions 2 and 3 following the announcement of a Broadcom bid for Qualcomm. And should Broadcom announce a bid, there’s a good chance that it will be quickly followed by a Qualcomm announcement declaring the bid inadequate. And by plenty of PR maneuvers from both firms.

Get your popcorn ready.

Broadcom, Apple and NXP Semiconductors are holdings in Jim Cramer’s Action Alerts PLUS Charitable Trust Portfolio. Want to be alerted before Cramer buys or sells AVGO, AAPL or NXPI? Learn more now.

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