The information technology sector is up almost 12.5% year to date, making it the best performing sector in the market for 2018. While investors who own shares of Amazon (AMZN), Microsoft (MSFT) and Alphabet (GOOGL) have seen returns of 52%, 23% and 17%, respectively, this year, there are technology companies that have underperformed.Some of these companies may rebound in the second half of the year. One such company could be chip maker Qualcomm (QCOM).

Company Overview

Qualcomm was founded in 1985 and its first product was a satellite that allowed long-haul trucking companies to locate and send messages to their drivers. Today, Qualcomm develops and sells integrated circuits for use in voice and data communications. The company has a market cap of more than $91 billion generated $23.2 billion in sales in 2017.

3^rd Quarter Earnings and Recent Company News

Qualcomm released its 3^rd quarter of fiscal 2018 earnings on July 25^th. The company earned $1.01 per share, topping analysts’ estimates by $0.30 and improving 21.7% year over year. Revenue grew 5.7% to $5.60 billion, $410 million above expectations.

There remains a dispute between the company and Apple’s manufactures regarding royalty payments made to Qualcomm. In the spring, Qualcomm announced that it was willing to make concessions to Apple that lowers the fees it charges for its wireless chips and patented technology.

Qualcomm was able to top sales estimates thanks in part to a $500 million royalty payment from Huawei. Huawei is the world’s largest maker of telecommunications equipment. This payment was a partial payment made while negotiations over licensing fees between Qualcomm and Huawei continue. While an offer of concessions and a partial royalty payment do not represent an end the licensing dispute, both moves are a step towards a resolution.

For nearly two years, Qualcomm has attempted to close its purchase of NXP Semiconductors (NXPI). NXP provides high-performance chips used in automotive and mobile payments end markets, which would have helped Qualcomm diversify its business away from mobile devices. While Qualcomm had gotten approval from almost every regulatory body needed to complete the deal, China was the lone holdout, likely due to the increasing trade tensions between the country and the United States. Because approval wasn’t a guarantee while the two countries are involved in a trade conflict Qualcomm decided to pull the plug on the acquisition.

Upside Potential

While technology is the best performing sector in 2018, shares of Qualcomm are flat so far this year. There are some reasons investors should be bullish on the company. While acquiring NXP Semiconductors would have diversified the company’s business model, Qualcomm had to extend its cash tender offer almost thirty times in an effort to finalize the acquisition. Combined with the lack of approval from China and the deal began to weigh on the stock of Qualcomm. Prior to the announcement that the deal was being terminated, shares had dropped approximately 10% year to date.

After the announcement of the termination, Qualcomm stated that it would buy back $30 billion worth of its own stock between now and September of 2019. This repurchase represented more than a third of the market cap at the timing of the announcement. Qualcomm will also repurchase up to $10 billion of shares through a Dutch auction by the end of August 2018.

While the company will have to pay NXP a $2 billion termination fee, analysts upgraded the stock almost immediately, raising both their buy ratings and price targets for Qualcomm. Based off of EPS estimates for this year ($3.61) and next ($4.19), Qualcomm has a forward price to earnings multiple of 17.7 for 2018 and 15.3 for 2019. By comparison, the S&P 500 and the iShares U.S. Technology ETF have a multiple of 24.4 and 26, respectively. 

Qualcomm’s dividend yield is also very attractive. At 3.9% currently, the yield is more than double that of the S&P 500’s (1.9%) and well above that of the 10-Year Treasury Bond (2.98% as of 7/30/2018). Qualcomm has a compound average growth rate for its dividend of nearly 14% over the past decade and almost 13% over the past five years. Qualcomm is one of the largest tech sector dividend-paying companies in the market.

Conclusion

Qualcomm’s deal for NXP is officially terminated. While the deal would likely have been a positive for the company, the approval process suppressed the stock price. While much of the technology sector was performing well, Qualcomm’s shares declined nearly double digits. Qualcomm announced a massive buyback while ending its pursuit of NXP. With a multiple that is more attractive than that of both the market and the tech sector, Qualcomm has upside potential from here. In addition, investors are paid a generous dividend yield while they wait for conflicts between Qualcomm and other technology names to be resolved.