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The Qualcomm PUT and The FABulous Year Ahead

The Qualcomm PUT and The FABulous Year Ahead
by Ed McKernan on 01-19-2012 at 5:14 pm

 Humor can arise in surprising ways and yet still be disguised to many. As I was researching Qualcomm the other day, I came upon the transcript of their last quarterly earnings and I had to laugh. In the midst of last summer’s European crises, when the Club Med (Greece, Italy, Spain and Portugal) Sovereign Debt was trying to be rolled over with few takers and stocks swooned across the globe, there was Qualcomm injecting a little humor into the markets. You see, in the midst of everyone selling, did a very bullish thing: they sold over $500M of PUTS and collected $75M doing so. At the last earnings call, none of the analysts inquired. Why does a company with $21B in the bank sell PUTS to earn $75M? The answer, I believe has to do with Qualcomm looking to raise its profile even further as they separate themselves from the rest of the mobile ARM camp. However, 2012 will require an even bigger bet the company move.

Throughout the 1990s, Alan Greenspan, disciple of Ayn Rand, and perhaps the most knowledgeable person on the planet in terms of the gives and takes of the economy liked to befuddle congress with presentations that were incomprehensible with the result being that he had great degrees of freedom in pursuing a monetary policy that he believed generated optimum economic growth with low inflation and a stock market that for the most part headed north. An economy, though is a complex thing and even though he thought he could calibrate the health and dynamism by monitoring things like weekly cardboard box production, outside forces could take the stock market down (e.g. the Asian Crises in 1997 and LTCM in 1998). When a crises occurred he would swing into action by implementing what became known as “The Greenspan PUT”. The Fed would immediately lower interest rates and stocks would head higher to the cheers of the investment class. The PUT has limitations, as is seen in our current crises, when debt loads get too large.

Qualcomm’s PUT, in the midst of the European crises was a signal to Wall St. that they believe very good times lie ahead regardless of whether Italy, Greece, France or the whole EU goes in the tank. Although market indications lately show that Europeans will forsake everything to get their hands on an Apple iPAD and iPhone. Perhaps even Italian three hour lunches. Not to worry the money printing has already begun. So, Qualcomm’s selling of PUTS in Q3 was a bullish signal that at the time of expiration in 2H 2012, the stock will be higher than the strike price (I am guessing between $45 and $50 as Qualcomm’s stock flirted with a low of $46). Qualcomm said the breakeven price of the PUT option is roughly $43 a share. Below that they have to write a check to buy the stock back.

Qualcomm’s $21B stash of cash is greater than Intel’s and will soon be three times that of nVidia, Broadcom and Marvell combined who make up the ARM camp that not only are Qualcomm’s chief competitors but licensees. Qualcomm stands as a tall Redwood in a forest of seedlings as it is more than an order of magnitude larger in sales than any of the current ARM campers. But there are major business decisions coming down the pike.

Qualcomm, along with Intel and Apple have the most direct impact on the shaping of the smartphone, tablet, ultrabook mobile Tsunami marketplace and yet each impact it differently. Intel is driving ultrabook to be the form factor that separates them from nVidia and AMD giving them a de-facto Monopoly position in the PC space while also pursuing Apple for the iPhone and iPAD processor business. Apple, we know owns the iTunes Walled Garden Ecosystem that gives them the upper hand in selecting from a cornucopia of suppliers for its next products. You can say that Qualcomm is the winner no matter what communications solution is chosen – whether it is its own chipset or a royalty bearing solution from Broadcom, Intel, Marvell and others. However the big money is in supplying the chips and that can be a problem or opportunity.

As mentioned in previous blogs, the economics of Mobile Tsunami are different than the PC market. Apple and Samsung continue to go Vertical in their supply chain to remove excessive margins. In return for a capital investment and guaranteed demand, Apple gets vendors to drop ASPs and margins. Intel is approaching Apple with a production model that can retain its standard 50-60% Gross Margins but ASPs lower than Samsung due to their 2-3 year process lead. Qualcomm on the other hand sells chips that include the TSMC margin on top of their own 60%+ gross margin.

 Bottom line: Does Qualcomm use its $21B cash to build a fab to eliminate TSMC margins and build next generation communications chips that aren’t available elsewhere? Do they approach Intel to Fab next generation standalone chips while offering Intel first rights on “volume integrated communications.” I don’t see Qualcomm moving to a complete IP model. However, the maturation of the very high volume mobile market combined with the economics suggest that the winners will either own Fabs or be IP Houses and a shakeout will take place among the Fabless. There is room for one profit margin, not two – unless you build at Intel. 2012 could be a very decisive year for Qualcomm.


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