Qualcomm (QCOM), a leading semiconductor company, came under pressure on October 23 Bloomberg reported that its long-term partner, Arm Holdings (ARM), was scrapping the licensing agreement between the two companies. I think it’s time to be cautious with Qualcomm stock, as this decision could negatively impact the company’s relationships with its key customers, potentially leading to revenue losses.
While Qualcomm has a long way to grow, aided by favorable long-term trends in the chip market, I’m neutral on the prospects for the company given the lack of clarity on the impact of Arm’s decision.
While I believe Qualcomm is well positioned to benefit from a recovery in the global semiconductor market, I am wary of the risks arising from the cancellation of Arm’s licensing agreement. According to BloombergArm Holdings has given Qualcomm a 60-day notice of termination of the licensing agreement that allowed the chipmaker to use Arm’s intellectual property to design and develop chips.
If the two companies fail to reach a new deal, Qualcomm will lose access to Arm’s instruction set architecture, which is used to create custom CPU cores. Qualcomm uses Arm’s architectural infrastructure to design chips for Android smartphones, which are the largest contributors to the company’s revenue.
Additionally, Qualcomm may have to redesign the recently introduced Nuvia-based chip designs, which will lead to a significant increase in development costs. This, in turn, will impact Qualcomm’s operating margins. Qualcomm may also have to substantially change its product development pipeline, which will impact the company’s product roadmap. Significant delays in new product launches should be expected, and these delays are likely to damage the company’s brand image as a reliable chipmaker that delivers on time.
In addition to the immediate impact resulting from the cancellation of Arm’s licensing agreement, I worry about the choices Qualcomm will have in a post-Arm era. One option would be to consider alternative chip design architectures such as RISC-V. The problem with this strategy is that switching to a new architecture will cost the company millions of dollars.
Such a transition will also create operational inefficiencies in the first few years, making it difficult for Qualcomm to keep its major customers satisfied. Qualcomm could also consider developing a new architecture internally to mitigate the threat of canceling Arm’s licensing deal, but the company would incur significant costs to build a new platform.
Regardless of which path Qualcomm chooses, the company appears to be heading into rough seas amid increasing competition in the chip industry and the tendency of big tech companies, such as Apple (AAPL), to develop chips themselves to reduce their dependence on technology. reduce. third party chip makers.
Given the challenges previously discussed, Qualcomm could try to find a middle ground with its long-term partner Arm Holdings to resolve the differences between the two companies. The company can agree to end this dispute by offering to pay higher royalties to Arm in exchange for using the company’s architecture. The two companies may also consider striking a new deal that includes new provisions for Qualcomm’s use of Arm’s chip design architecture for both mobile and server markets.
In addition, the two chip companies may consider working together on new joint development projects with a clearly defined revenue share. If all these strategies fail, Qualcomm could resort to using Arm’s standard chip design architecture instead of the custom architecture that has led to legal issues since 2022.
While my sentiment toward Qualcomm has been affected by Arm’s license revocation, I still believe the company has a long growth trajectory, aided by favorable industry conditions. Qualcomm is one of the leading players in the mobile chiplet market, with a 26.5% share of the 5G smartphone chip market, only behind MediaTek’s 29.2% market share. With global adoption of 5G expected to increase in the coming years, Qualcomm’s Snapdragon chips are likely to remain in high demand, driving sales growth.
Qualcomm is also expanding into new product categories, such as AI PCs, opening new doors for growth. According to CanalysOnly 19% of total PCs shipped in 2024 will be AI PCs, but AI PC penetration is expected to reach 60% by 2027, underscoring the strong growth potential of this market segment. As one of the leading chipmakers for AI PCs, Qualcomm is well positioned to benefit from this favorable development.
In addition, Qualcomm’s automotive business is gaining traction, allowing the company to diversify its revenue streams. In fiscal 2023, auto revenues rose 24% year-over-year to $1.9 billion, helped by increased spending by automakers on advanced technologies such as high-end infotainment systems and autonomous driving. As of 2022, Qualcomm was the leading chip supplier to the automotive industry with an 80% market share, underscoring the company’s strong position in this fast-growing sector.
Despite the start to growth for Qualcomm, some analysts have grown cautious about the company’s prospects in recent weeks. For example, JPMorgan analysts added Qualcomm to its negative catalyst watchlist earlier this week as they expect the company to provide weak guidance for the coming quarter. On October 21, Barclays also claimed that Qualcomm is lagging behind some of its fellow chipmakers in AI advances.
Nevertheless, Qualcomm’s average price target, based on the ratings of 21 Wall Street analysts, is $214.13, implying an upside potential of 25.1% from the current market price.
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With a price-to-earnings ratio of 17 compared to 50 for Nvidia (NVDA) and 45 for Advanced Micro Devices (AMD), QCOM appears cheaply valued. However, Qualcomm’s dependence on Arm’s chip design architecture paints a bleak outlook for the company, as failure to renegotiate the deal terms could lead to a cancellation of the partnership. Despite being attractively valued, QCOM stock could struggle if there isn’t a good solution to mitigate the threat posed by Arm. For this reason, I am neutral on QCOM today.
Arm Holdings’ possible cancellation of a chip architecture deal with Qualcomm will likely limit Qualcomm’s growth potential in the near term. Qualcomm’s alternative options also suggest that the company’s operating margins could come under pressure in the coming quarters. Despite Qualcomm’s long period of growth, I believe investors should be cautious given the uncertainty surrounding the prospects for Qualcomm’s mobile chiplet business.
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