February 26, 2018, was an eventful day in the saga surrounding Qualcomm Inc. (“QCOM”, “Qualcomm” or the “Company”), Broadcom Limited (“Broadcom” or “AVGO”), and the much-ballyhooed 5G wireless technology. Prior to market open, investors were excited by the prospects of the company engaging constructively with AVGO, especially given QCOM’s filing with the SEC outlining its intent to negotiate, albeit subject to conditions (reasonable in our judgment). The company also provided a clear indication that a higher price from AVGO would seal the deal. What the “higher” price should be, surfaced later via a story in the Financial Times, which said that an enterprise value of $160B including $25B of assumed debt, implying $135B for QCOM’s equity, could seal the deal. QCOM’s current market capitalization is approximately $98B.
Then, on the same day Federal Communications Commission chairman Ajit Pai, gave a keynote speech at the Mobile World Congress in Barcelona – which happened to be an early afternoon in New York – where he talked about kick-starting 5G implementation as early as in the fall of 2018. Similar comments were also attributed to Rajeev Suri, Nokia’s CEO, who said that he sees both China and the U.S. moving quickly to implementing 5G, with capital expenditure schedules pulled forward by a year.
One of QCOM’s critical defenses against AVGO’s overtures has been its significant investment in 5G technologies, and the company’s repeated assertion that it expects 5G investments to start paying off in the 2020 time-frame. So, some investors could be excited to see a return on 5G coming to fruition sooner and ended up bidding up the stock. Even if that were not the case, it still helps QCOM in its negotiations with Broadcom going forward.
How serious is AVGO about its bid to buy QCOM? We don’t know.
Reason 1 it is not clear to us: AVGO suggested a way out to QCOM.
In ANTYA’s opinion, whatever motives compelled AVGO to bid for QCOM initially, once it became apparent that the company was unlikely to be bulldozed into submission, AVGO appears to have had second thoughts about moving forward. Why do we say that? For the simple reason, that AVGO shot itself in the foot by publicly stating that QCOM should not increase its bid for NXP Semiconductor N.V. (“NXPI”), knowing sufficiently well that the company was locked in a battle with activist and merger-arbitrage funds, whose only intent was to get a higher price. Moreover, that higher price was already telegraphed to Qualcomm by the various funds involved.
Since no acquisition bid opens at the expected purchase price (case in point the bid on the company raised by AVGO from $60 to $82), it would be futile to argue that the company shouldn’t increase its bid. Since Qualcomm did raise the bid on NXPI, it is evident that QCOM took the bait to keep AVGO at bay, and used its NXPI transaction as a poison pill.
Qualcomm’s success with NXPI also provides AVGO with a way out, because the management of Broadcom has been steadfast in touting its price discipline track-record regarding its past acquisitions, and can now walk away with its head held high.
Reason 2 it is not clear to us: AVGO Lowered the offer price
To add fuel to fire, AVGO lowered the bid on QCOM by $4.10 per share, or $6.2B, upon QCOM’s success with NXPI, since in AVGO’s view value transfer had occurred from QCOM to NXPI. Clearly, if QCOM thought $82 was too low, it would not even consider $79 as a serious offer. That allows QCOM to walk away, and AVGO to save face once again by repeating that it is trying to be disciplined.
Why is Qualcomm engaging with Broadcom now?
It’s not that everything has worked out in the company’s favor either. Proxy advisory firms have weighed in on Broadcom’s proposed slate of six directors for the upcoming shareholder meeting on March 6, 2018. Institutional Shareholder Services (“ISS”) says shareholders should nominate four of Broadcom’s representatives, while Glass Lewis (“Lewis”) goes so far as to say that nominate all six directors on QCOM’s board, which has a current
strength of eleven. ISS was of the view that if all six nominees of AVGO were to be elected, QCOM may not be able to negotiate a fair price with AVGO. Lewis, on the other hand, believed that Qualcomm “consistently dragged its feet” in engaging with Broadcom.
These developments do force Qualcomm’s hand, and hence to address any inertia that it might have shown previously, the company filed a detailed response with the SEC on February 26, 2018.
What does Qualcomm’s current proposal say?
QCOM has put forth a substantive proposal that highlights some key areas of interest for all stakeholders, especially stockholders who would be viewing the ongoing battle with longer-term value creation in mind. Stockholders would like to maximize the present value of the embedded intellectual property and business opportunities in QCOM, whereas proxy advisors are more concerned with fiduciary obligations of the board, and ensuring that in the event of M&A dollar value of equity is maximized. Therefore, proxy recommendations are more likely to impact voting by ETFs or Index funds, whereas active managers would pay attention to the proposal put forth by QCOM.
As reported to the SEC in its filing, Qualcomm would like to:
- Finalize non-price terms
- Execute NDA and begin bilateral due diligence
- Agree on approach to providing information on licensing business; and
- Arrange a meeting focussed on price.
All of these seem logical to us especially points 2 and 3. Since AVGO’s revised bid comprises some stock and some cash, reverse due-diligence by QCOM becomes imperative. Thus, the company’s assessment that so far Broadcom has been flying blind, and hence it would be able to see more value in QCOM once a data room is a set-up to share information; is defensible. The exercise would also justify an increase in price to be paid by AVGO if it chooses to do so, or it could decide new information does not warrant a higher offer. In either instance, it is a face-saving measure for Hock Tan, and it would be wise to accept QCOM’s proposals.
Point 3 raised by the company is the most crucial issue in this entire exercise. It is the licensing business of the company that is either an ace in its armor as it has been in the past, or will be a thorn in its side going forward. We find AVGO’s silence on this issue perplexing, to say the least, and believe their retort that it could “pose issues under antitrust laws” as disingenuous. Therefore, QCOM’s proposal to hire an antitrust law firm acceptable to both parties to hear out Broadcom seems rational to us. We already discussed this issue previously in Broadcom Limited – Staring at Defeat.
Why is Broadcom upset with Qualcomm’s proposal?
Responding to QCOM’s proposal Broadcom said that, “Broadcom’s Attempts at Genuine Engagement Met with Qualcomm’s “Engagement Theater”. This is very interesting because Broadcom would like to agree to merger terms including price first, and then agree to reverse due-diligence, whereas from our perspective Qualcomm has the right to conduct due-diligence first, and then decide on an appropriate price. However, AVGO could still change the dynamic by offering an all-cash transaction, and that would take Qualcomm’s reverse due-diligence proposal off the table.
In our assessment, Broadcom sounds desperate and in a tearing hurry, knowing very well that it is not able to call the shots. In the same letter, Broadcom also said, “Qualcomm refused to confirm that it will hold its previously scheduled stockholder vote on March 6”.
That didn’t sit well with Qualcomm which came back and issued a rebuttal on the same day, i.e. February 26, 2018, saying that “The latest statement issued by Broadcom is disingenuous and clearly intended to create a false impression about Qualcomm’s level of engagement. In fact, Qualcomm has repeatedly attempted to engage with Broadcom on issues including price, including at meetings on February 14 and February 23. In each of those meetings, Broadcom has refused to engage on price.”
So, here we are, two large companies in the semiconductor business engaged in a war of words, and in a bitter boardroom battle which appears to be getting uglier by the day.
A Difference in Styles is Evident
In ANTYA’s opinion, at Qualcomm, historically IP and R&D have led the business forward, ultimately resulting in its quasi-dominant position in wireless chips and technology. Therefore, irrespective of the company’s business practices which are under scrutiny everywhere, it must have been managed radically differently from AVGO, which is an amalgamation of various chip manufacturers.
This is also evident in the approach followed by each entity outlining its position on the proposed transaction as well. Qualcomm has been methodical in highlighting its challenges and opportunities, whereas Broadcom has described a few outlandish targets, and is primarily telling stockholders to “Trust Us”.
That doesn’t cut it for us at ANTYA and is unlikely to sway medium to long-term global technology investors either.
What do we expect on March 6, 2018?
The vote on March 6 comes down to three distinct constituents:
- Longer-term investors who decide that they believe in Qualcomm’s plan or vision 2020 and therefore vote for Qualcomm’s slate
- Short-term investors that want the immediate gratification of a stock uplift driven by a successful deal and hence vote for AVGO’s slate
- Index Funds that hold approximately 24% of stock including BlackRock Inc. (7.51%), The Vanguard Group (7.20%), State Street Global Advisors Inc. (4.02%), and the rest.
We expect Qualcomm’s slate to get re-elected
Thinking through the position of longer-term investors and Index funds, we would say that there is a more than 2/3rd chance that Qualcomm’s existing slate of directors gets voted in. Our reasoning on that depends a lot on Larry Fink’s (CEO of BlackRock Inc., the world’s largest passive institutional investor) view of the world. Fink has repeatedly bemoaned a lack of long-term perspective on Wall Street and has said in many different forums that investing more in R&D and Capex is the need of the hour. Fink believes a long-term outlook is required to build great businesses.
(https://www.nytimes.com/2015/04/14/business/dealbook/blackrocks-chief-laurence-fink-urges-other-ceos-to-stop-being-so-nice-to-investors.html?_r=0)
That makes us think that BlackRock is unlikely to back Hock Tan’s agenda of slash & burn, and divestitures to please antitrust authorities. If BlackRock doesn’t back this, it is unlikely that other Index funds will either. Although BlackRock may be willing to support a nominee from AVGO to spice things up at Qualcomm. Investors are also very much aware of growth by acquisition stories repeatedly gone awry, most recently Valeant Pharmaceuticals Inc. Therefore, we believe that at most one or two of AVGO’s nominees are likely to be elected to QCOM’s board. In that scenario, either AVGO must bid up or give up.
What happens after the Shareholder Meeting?
If AVGO fails to get a definite nomination of its slate, it walks away from the deal, and QCOM’s stock price falls to around $60 or thereabouts, assuming NXPI will close successfully upon a favorable decision by China this month or next.
If AVGO wins its nominations, then the stock price moves up to $70 or thereabouts and stagnates for 12-18 months, till regulatory approvals and closures are achieved worldwide. AVGO may improve its bid marginally to suggest that its slate is not conflicted and that the newly elected directors are still working in the best interest of Qualcomm shareholders.
If AVGO walks away, and China doesn’t approve NXPI, then QCOM goes back to the low fifties, with a resolution of Apple-related lawsuits, and the FTC lawsuit determining the ultimate outcome in 2019.
Our base case is that AVGO walks away, QCOM gets NXPI, and a slow and steady revival begins afterward.
Stay tuned. It’s fun!
