QCOM--Tuesday July 25, 3:56 pm Eastern Time
Morningstar.com
Qualcomm Adds Value through Subtraction
By Todd P. Bernier
Qualcomm's (Nasdaq: QCOM - news) announcement Tuesday that it will spin off its semiconductor business is good news for shareholders, as it will allow management to focus on developing its code division multiple access (CDMA) technology. Moreover, the spin-off is likely to increase the company's value by separating a slow-growing business from a fast-growing one. Investors are cheering the good news, sending the stock up about 8% so far today.
The strategy is to separate two business segments that possess very different business profiles. The company's technology segment consists mainly of a portfolio of CDMA patents, which generate a stream of royalty payments from the handset makers that license Qualcomm's technology for their phones. This business is growing very rapidly. In the June quarter, the segment reported revenue growth of 38% from the same quarter a year ago. On top of this torrid topline growth, pretax margins were 87%, as virtually all royalty revenue falls directly to the bottom line.
The company's chip-set business is much more commoditylike and characteristic of a traditional semiconductor firm. This segment increased revenue at a clip of just 6% during the June quarter, despite shipping a higher volume of chip sets. Pretax margins fell nine percentage points, to 32%, causing profits in this segment to decline more than 15% from the prior-year period. The lower rate of earnings growth will prevent this segment from commanding the same price/earnings multiple as the technology segment.
Splitting the chip-set segment into a separate business will also allow the new company to leverage its own patents to gain access to the global system for mobile communications (GSM) technology platform, a digital-communication standard that is much more prevalent than CDMA outside the United States. While Qualcomm will focus on developing CDMA technology, the spun-off company could make chip sets for the next generation of the transmission standard, whether it's based on CDMA or GSM. Regardless of which standard is adopted, Qualcomm will receive a royalty payment.
By separating the slower-growing chip-set business from its CDMA technology cousin, the smaller, royalty-driven Qualcomm will show much higher revenue-growth rates. As a result, the valuation multiple attached to the remaining business will be higher than current levels. From this perspective, today's announcement by management was a brilliant move.
Todd P. Bernier can be reached at todd_bernier@morningstar.com.
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