Name That Trade – $QCOM: San Diego Poo

by Dan July 22, 2015 2:03 pm • Commentary

Event: QCOM reports Q2 results tonight after the close, the options market is implying about a 4.5% one day move which is shy of the 4 qtr average one day move of about 6.5%, ranging from down 1% to down 10%.  

Price Action / Technicals:  The stock has been a train-wreck to say the least, down 13% year to date and down 20% from the 52 week and 15 year highs made last year.  The stock has been in a massive downtrend making a series of lower highs and lower lows:

[caption id="attachment_55550" align="aligncenter" width="600"]QCOM since Jan 2014 from Bloomberg QCOM since Jan 2014 from Bloomberg[/caption]

Fundamentals: Umm bad.  The company started the year with regulatory and licencing issues in China, and appeared to be headed towards a year end that could show softness in Chinese demand. On the product front, QCOM’s LTE chip was not included in the Samsung’s Galaxy phone released in April and there are fears that it may not be in the upcoming iPhone.

The company is in crisis mode, with earlier this year announcing a massive buyback (read here), they have activists on their case, and the WSJ reported earlier in the week that the company is conducting a strategic review that could include a breakup (read here), from WSJ:

Any breakup of the company would likely separate Qualcomm’s chip-production business from its patent-licensing operation. The company, which has a market capitalization of $104 billion, gets about two-thirds of its roughly $26 billion in annual revenue from the chip business. But about two-thirds of its roughly $8 billion in yearly profit comes from royalties from the sale of smartphones that use technology it pioneered.

Valuation: the company has 28% of its $105 billion market cap in cash, and they seemed poised to put it to work. I suspect we will see a combination of aggressive buybacks and possibly a large acquisition. The company has stated they will raise debt to help fund.  QCOM trades at 13x expected 2016 earnings growth of 6%.  While the stock screens as cheap with its 3% dividend yield and rock solid balance sheet, earnings are expected to decline this year by 10%, registering its first yoy drop since 2009.

FY3Q adj. EPS est. 95c (range 90c-$1.05); April 22, QCOM forecast 85c-$1.00
FY3Q rev. est. $5.84b (range $5.59b-$6.08b); QCOM forecast $5.4b-$6.2b
FY3Q gross margin est. 59.5% (range 58%-61%)
FY4Q adj. EPS est. $1.08 (range 86c-$1.25)
FY4Q rev. est. $6.13b (range $5.79b-$6.36b)
FY15 adj. EPS est. $4.75; QCOM forecast $4.60-$5.00
FY15 rev. est. $25.97b; QCOM forecast $25b-$27b

My View: Aggressive share buybacks and a potential breakup seem like fairly juicy catalysts.  The stock appears cheap, but is in an industry that feels like it is on the precipice of an implosion.  I suspect the stock gets sold on pops, and likely holds that downtrend until there is evidence of a turn in their business.

Potential Trades:

Bullish: If you think the stock could pop on any strategic news, then consider defined risk short dated call spreads.

Hypothetical Trade: QCOM ($64.40) Buy Aug 65/70 Call Spread for 1.30

Break-Even On Aug Expiration:

Profits: up to 3.70 between 66.30 and 70 with max gain at 70

Losses: up to 1.30 or 2% of the underlying stock price between 65 and 66.30 max loss below 65


Bearish:  if you think rallies are sold, then consider put flies in Aug.

Hypothetical Trade: QCOM ($64.40) Buy Aug 65/60/55 Put Fly for 1.25

Break-Even On Aug Expiration:

Profits: up to 3.75 between 63.75 and 56.25, max gain of 3.75 at 60

Losses: up to 1.25 or 2% of the underlying stock price between 63.75 and 65 & between 56.25 and 55, with max loss of 1.25 above 65 and below 55