Following QCOM’s Q2 results in late July, we put on a bullish trade on the earnings dip, playing for a gap-fill. The stock continued its decline another 5%. after the 6.6% one day earnings gap, making our trade a quick loser. QCOM has since bounced back to the level we put our trade on, but the decay in the longer dated options is making it increasingly unlikely that this trade will be profitable without an identifiable catalyst.
We considered closing this position on Thursday when the stock could not break above its 50 day moving average on the upside but decided to give it a few days. The stock has not been able to get through that $77.50 level, which is our strike, but has held its 200 day moving average on the downside. It is a tough call here. Technically, it could be consolidating for the gap fill that we had originally been playing for, but the stock continues to show very poor relative strength to its peers and the broad market. Vol is very low in these options at 13.5, but will likely go lower without much movement as Oct expiration will not catch their next earnings event.
At this point I am going to cut my losses and re-evaluate the bullish thesis.
Action: Sell to Close QCOM ($76.63) Oct 77.50 call at 1.01 for a .64 loss
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Previous Post July 24th, 2014: New Trade – $QCOM: Shanghai Surprise
QCOM is down today more than double the implied move following earnings that missed expectations and offered squishy guidance. The main driver for the selling seems to be issues with royalty collection in China. Patents not being honored in China? Crazy.
From Bloomberg:
Qualcomm Inc. (QCOM) shares fell as much as 7 percent after the chipmaker said it’s struggling to collect license revenue from handset makers in China, the world’s largest mobile-phone market, threatening profit growth.
Qualcomm yesterday gave a quarterly earnings forecast that fell short of analysts’ average estimate. The company cited missed royalty payments for chips running on the new long-term evolution standard as manufacturers fail to report phone sales or refuse to sign contracts. Licensing is Qualcomm’s most profitable business.
…..
Qualcomm’s disclosure signals an escalation of its challenges in China, a market the company has been touting as a main driver of future earnings growth. Even as Qualcomm sells more chips in China, Chief Executive Officer Steve Mollenkopf must work to end the royalty disputes with phone makers and resolve a government investigation into its business to get licensing back on track in the world’s most populous country.
“Qualcomm told investors that they had the China customers under contract, that it’s all worked out,” said Suji De Silva, an analyst at Topeka Capital Markets. He has a hold rating on the stock. “Now we’re getting a sense that it’s still a challenge. Qualcomm is trying to monetize its technology, and China is a more challenging market.”
It’s not uncommon for QCOM to sell off on earnings and a lot of times the selloff is almost immediately bought:
Check out the two year chart with earnings dates signified by the green and red Es:
Now, the concern on the China issue is a bit more significant given that QCOM earnings growth over the long term is predicated on progress in China. Here’s a comment from Goldman research on the topic:
The uncertainty around royalties in China is a meaningful negative, given our expectation that China will account for more than 50% of handset sales long term.
QCOM is still a lynchpin company for the smartphone market given its technological lead over other chipmakers, but the Chinese problems need to be sorted for long-term earnings visibility.
Despite the miss and guide down, consensus estimates are for 15% eps growth and 7% sales growth. With the stock trading at 14.7x that eps estimate, the stock trades below a market multiple, and even below INTC. This is not a frequent occurrence, and on a trailing basis, the chart below shows the converegnce in just 2 periods over the last 5 years:
QCOM is a cheap stock, has solid management, and a rock solid balance sheet that sports 26% of their market cap in cash and no debt. It has a huge commitment to cash return between a dividend that yields 2.2% and multi-billion share buyback (bought back $1.35 billion in shares last qtr and paid $700 mln in dividends), oh and not to mention near monopolies in many of their business verticals.
In an environment where activists have recently taken on some fairly large targets in tech, namely AAPL & EBAY by Carl Icahn ($580 billion and $66 billion market caps respectively) and EMC by Elliott Management ($60 billion market cap), QCOM with an enterprise value of $95 billion could make it activist bait in a heartbeat. Or why not a merger between the factory-less QCOM who dominates in mobile but is nowhere in PC/Servers, and the factory-heavy INTC that is severely lagging in mobile but has recently seen a lift from strong performance in enterprise demand for PCs and servers?? I am not a regulatory expert, but I see little overlap, and could see billions in potential cost savings. Ok maybe that’s a pie in the sky suggestion, but wouldn’t that be a perfect deal from a sentiment standpoint at this stage of the market cycle??
With the stock down today on what is clearly not good news, and given the stock’s history after filling in the earnings gap over the last couple years I want to make a near term bet that it does so again. I also feel that in the activist environment that we are in QCOM seems as good as any large cap candidate for an agitator to push for increased capital return or some way to unlock shareholder value.
TRADE – Bought to open the QCOM ($76.20) Oct 77.50 calls for 1.65
Break-Even on Oct Expiration:
Profits: above 79.15, up about 4%
Losses: up to 1.65 between 77.50 and 79.15, with max loss of 1.65 or about 2.2% of the underlying stock price.
Rationale: Sentiment is clearly poor in the stock, which may or may not compensate for the new fundamental headwinds, but implied vol is cheap, and for those looking to make contrarian bullish bets, long premium strategies with defined risk are the way to play in our view. The 2 year chart below of 30 day at the money implied vol shows the post earnings decline, but given the new concerns in China, i would suspect vol would not go much lower back towards the previous multi-year lows:
[caption id="attachment_43375" align="aligncenter" width="600"]
From Bloomberg[/caption]
On a bounce towards our long strike, I would look to spread the long calls by selling a higher strike call to lower my break-even and lock in a portion of the appreciation.