Qualcomm (QCOM), a leading semiconductor company, came under pressure on October 23 after Bloomberg reported that its long-term partner, Arm Holdings (ARM), was scrapping the license agreement between the two companies. I believe it’s time to be cautious about Qualcomm stock as this decision may adversely impact the company’s relationships with its main customers, potentially leading to a loss of revenue.
Although Qualcomm enjoys a long runway to grow, aided by favorable long-term trends in the chip market, I am neutral on the prospects for the company given the lack of clarity surrounding the impact of Arm’s decision.
Although I believe Qualcomm is well-positioned to benefit from a recovery in the global semiconductor market, I am wary of the risks posed by Arm’s license deal cancellation. According to Bloomberg, Arm Holdings has given Qualcomm a 60-day notice of cancellation of the license deal that allowed the chipmaker to use Arm’s IP to design and develop chips.
If the two companies fail to strike a new deal, Qualcomm would lose access to Arm’s instruction set architecture which is used to create custom CPU cores. Qualcomm uses Arm’s architectural infrastructure in designing chips for Android smartphones, which is the biggest contributor to company revenue.
In addition, Qualcomm may have to redesign recently-introduced Nuvia-based chip designs, leading to a notable rise in development costs. This, in turn, will impact Qualcomm’s operating margins. Qualcomm may also have to materially change its product development pipeline, affecting the company’s product roadmap. Significant delays should be expected for new product launches, and these delays are likely to hurt the company’s brand image as a reliable chipmaker that delivers on time.
In addition to the direct impact resulting from the cancellation of Arm’s license deal, I am worried about the choices Qualcomm is left with 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 shifting to a new architecture will cost the company millions of dollars.
Such a transition will also give rise to operating inefficiencies in the first few years, making it difficult for Qualcomm to keep its major clients satisfied. Qualcomm may also consider developing a new architecture in-house to mitigate the threat posed by Arm’s license deal cancellation, but the company would have to incur substantial costs to build a new platform.
Regardless of which path Qualcomm chooses, the company seems to be heading toward rough seas amid the increasing competition in the chip industry and the tendency of major tech companies, such as Apple (AAPL), to develop chips in-house to reduce their reliance on third-party chipmakers.
Given the challenges discussed earlier, Qualcomm may try to find some middle ground with its long-term partner, Arm Holdings, to settle the litigation issues between the two companies. The company may agree to end this dispute by offering to pay higher royalty fees 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 the use of Arm’s chip design architecture by Qualcomm for both mobile and server markets.
In addition to this, the two chip companies may consider collaborating on new joint development projects with a clearly defined revenue share. If all these strategies fail, Qualcomm may resort to using Arm’s standard chip design architecture instead of the custom architecture that has given rise to legal issues since 2022.
Although my sentiment toward Qualcomm has been impacted by Arm’s license cancellation, I still believe the company enjoys a long growth runway aided by favorable industry conditions. Qualcomm is one of the leading players in the mobile chiplet market, with a market share of 26.5% in the 5G smartphone chip market, only behind MediaTek’s 29.2% market share. With global 5G adoption expected to boom in the next few years, Qualcomm’s Snapdragon chips are likely to remain in high demand, boosting revenue.
Qualcomm is also expanding into new product categories, such as AI PCs, opening new doors to grow. According to Canalys, just 19% of total PCs shipped in 2024 will be AI PCs, but AI PC penetration is expected to reach 60% by 2027, highlighting 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.
Moreover, Qualcomm’s automotive business is gaining traction, helping the company diversify its revenue streams. In Fiscal 2023, automotive revenue grew 24% year-over-year to $1.9 billion, aided by the increased spending of automakers on advanced technologies such as high-quality infotainment systems and autonomous driving. As of 2022, Qualcomm was the leading chip supplier to the automotive industry with an 80% market share, which highlights the company’s strong footing in this fast-growing sector.
Despite the growth runway ahead of Qualcomm, some analysts have turned cautious about the company’s prospects in the last few weeks. For instance, JPMorgan analysts added Qualcomm to its negative catalyst watchlist earlier this week as they expect the company to issue weak guidance for the upcoming quarter. On October 21, Barclays also claimed that Qualcomm is lagging some of its chipmaker peers in terms of AI progress.
Nevertheless, based on the ratings of 21 Wall Street analysts, the average Qualcomm price target is $214.13, which implies an upside potential of 25.1% from the current market price.
At a forward P/E of 17 compared to 50 for Nvidia (NVDA) and 45 for Advanced Micro Devices (AMD), QCOM seems cheaply valued. However, Qualcomm’s reliance on Arm’s chip design architecture paints a bleak outlook for the company, as failure to renegotiate deal terms may lead to a cancellation of the partnership. Despite being attractively valued, QCOM stock may struggle in the absence of a good solution to mitigate the threat posed by Arm. For this reason, I am neutral on QCOM today.
Arm Holdings’ potential cancellation of a chip architecture deal with Qualcomm is likely to limit the near-term growth potential of the latter. Qualcomm’s alternative options also suggest the company’s operating margins may come under pressure in the next few quarters. Despite the long growth runway enjoyed by Qualcomm, I believe investors should tread carefully given the uncertainty surrounding the prospects for Qualcomm’s mobile chiplet business.
