Name That Trade – $QCOM: Chips and Dip

by Dan November 6, 2014 1:55 pm • Commentary

Yesterday we laid out our thoughts heading into a QCOM’s fiscal Q4 earnings print and detailed a bearish trade that targeted a 10% move lower to $70, based on our thought that:

With the stock pushing against technical resistance, and the fundamental backdrop far from stellar, the risk/reward in QCOM shares seems skewed to the downside for the first time in many years.

Today the stock is having its worst one day earnings decline (down 11.4%) in 4 years.  Last night on Fast Money when the stock was trading $72 I said that the stock should find some support at last month’s low around $70, and the stock is well below there now at $68.40.  After a look at the results and commentary, it does not appear that QCOM’s royalty issues will be easy to quantify, especially for just how long they will take to get resolved.

Analysts now expect QCOM’s earnings to grow a measly 4% in the current fiscal year 2015, and sales to grow at 9%. The 4% eps growth would mark the lowest year over year increase in 5 years.  So growth is in the tank, and issues in their largest region of potential growth is murky at best. And the company is facing probes from the FTC and the European Commission.  Investors suddenly view the stock as dead money.

Once there is more clarity, I suspect that the company’s pristine balance sheet, with $32 billion in cash, representing 28% of the company’s $114 billion market cap, with no debt will attract activists.  But this is likely to take some time.

QCOM will host their annual analyst meeting on November 14th in New York, which could serve as a near term catalyst.

Technically the chart is broken, as today’s volume will likely be the largest in years, with $65 looking like the next real support level:

QCOM 2yr chart from Bloomberg
QCOM 2yr chart from Bloomberg

From an implied vol standpoint, options prices remain elevated after the results and the gap lower, but we suspect as the selling abates that IV should moderate a bit, back to the high teens:

QCOM 1yr chart 30 day at the money IV from Bloomberg
QCOM 1yr chart 30 day at the money IV from Bloomberg

IN SUM, the stock has had its share of headwinds, many we suspect will be resolved in the coming months, with management having the opportunity to shed more light on the issues in the coming weeks.

The situation with EBAY earlier this year has us thinking that QCOM will be an activist target.  It’s a similar situation in many ways – a large cap prior leader with a near monopoly in their space, which has underperformed most peers and the broad market, with multiple levers to pull to unlock shareholder value.  You know the rest with EBAY.  Carl Icahn’s involvement has helped the shares, but not massively as investors await the spinout of PayPal.  With QCOM, I assume its a bit different, but in the past I have opined about the potential synergies of a merger with INTC, and the lack of overlap with their core competencies (PCs and mobile). That is a low probability outcome, as it would likely face some serious regulatory scrutiny, but it would make a lot of sense.

With QCOM shares approaching 18 month lows, I suspect large investors with financial engineering degrees could take a strong interest in the woefully under-levered company with an interest towards increased capital return. In the quarter just ended, the company bought back $638 million worth of stock and paid a 42 cent dividend that yields 2.45% annually.  But this will likely take some time, as activists may want to see some progress on the regulatory front before getting involved.  With this in mind, I would want to look out a bit, possibly as far as April expiration: 

We want to lay out the trade that we are eying, but the ideal entry would be a bit lower, possibly near that $65/66 level identified above.

HYPOTHETICAL TRADE:  QCOM ($68.40) Buy April 70/80 call spread for 2.50… if the stock were $65 we would probably roll down strikes to the $67.50/77.50 call spread for about the same premium.

Stay tuned, lets see if tomorrow brings one more washout day offering us our ideal entry.



Previous Post November 5th, 2014:  Name That Trade – $QCOM: Activist Bait?

QCOM reports earnings today after the close.  I detailed the earnings setup in yesterday’s preview, with the following conclusion:

Our View:  QCOM has consistently been viewed by investors as a Growth at a Reasonable Price stock over the past 5 years.  However, the “Growth” part of that equation is starting to get strained.

QCOM is a 15x P/E stock, so the valuation remains quite reasonable.  But EPS growth over the next 2 years is only expected to average around 5-6%, on sales growth of about the same.  That’s a far cry from the 10-30% EPS growth over much of the past 5 years.  More worrying perhaps is the possibility that the smartphone market has become saturated in the near term, which could hurt QCOM and possibly cause flat EPS growth over the next year.

With the stock pushing against technical resistance, and the fundamental backdrop far from stellar, the risk/reward in QCOM shares seems skewed to the downside for the first time in many years.

That’s the overall view.  We wanted an options trade that took those factors into account without risking too much on just the earnings event.  With that in mind, here was the idea:

We did not execute this trade because of the reasoning explained in the rationale, though this was our preferred structure.

Hypothetical Trade:  Buy the QCOM ($77.10) Dec20th 77.5/70/62.5 put butterfly for $1.75

-Buy 1 Dec20th 77.5 Put for 2.50

-Sell 2 Dec20th 70 Puts at 0.45 each or 0.90 total

-Buy 1 Dec20th 62.5 Put for 0.15

Break-Even on Dec20th Expiration:

Profits: btwn 64.25 and 75.75 make up to 5.75 with max gain of 5.75 at 70

Losses: btwn 62.50 and 64.25 lose up to 1.75, btwn 75.75 and 77.50 lose up to 1.75, below 62.5 and above 77.5 lose full 1.75

Rationale:  QCOM faces significant resistance between $78 and $82.  Add to that the high bar the stock has for both this quarter and next quarter, and I would be quite surprised to see a beat on both the current expectations as well as guidance for next quarter.  That’s the risk that could cause a breakout to new highs, but I see it as low probability considering the stock’s backdrop.  Finally, the chip sector as a whole has generally gotten hit on earnings reports in the past month.

BUT, the reason why I did not pull the trigger on this trade is that QCOM is one of the very few remaining large cap tech stocks that has a totally unlevered balance sheet.  The company has $33 billion in cash and no outstanding debt.  As a result, the upside risk is that QCOM announces a significant levering of its balance sheet, which could be the one major positive catalyst for the stock outside of earnings.

As for the structure, the Dec put fly targets the October low around $70.  The risk/reward is attractive since the break-even of the trade is $75.75, which is only 1.5% lower than the current level.  This structure also holds its value ok if QCOM is flat to slightly higher tomorrow after the report.