Asking Doesn’t Mean Buying – News Of Qualcomm Potential Takeover Of Intel

Summary:

• News broke late last week of Qualcomm approaching Intel for a potential takeover, sending Intel shares up 3.4% and Qualcomm shares down 3% on Friday.
• We don’t think the deal will lead anywhere for a couple of reasons.
• Regulatory hurdles, including CHIPS Act funding, and Qualcomm’s lack of foundry expertise make the acquisition impractical.
• Additionally, Intel’s valuation is extremely low at the moment, making it all the more unlikely that management will accept a bid.
• We recognize Qualcomm’s serious diversification efforts, and commend them, but the news doesn’t change our sentiment on either stock.

QUALCOMM (NASDAQ:QCOM) (NEOE:QCOM:CA), the fabless chip giant specializing in smartphone processors, approached Intel (NASDAQ:INTC) (NEOE:INTC:CA) about a potential takeover sometime over the past few days, according to a Wall Street Journal report that first broke the news before other outlets confirmed it. Representatives from both companies declined to comment, but that didn’t stop the news from sending Intel shares 3.4% higher Friday and weighing Qualcomm shares down 3% the same day.

If this deal were to go through, which we don’t think it will, it would fundamentally change the dynamics of the semiconductor market, not to mention that it would be one of the largest tech mergers to date. In fact, it would mark the largest takeover since Broadcom (AVGO) tried to buy Qualcomm back in 2018. There are a couple of reasons why we think this news is unlikely to lead anywhere.

Here’s why

To begin with, Intel is valued at around $93B, almost half of Qualcomm’s, at around $188B. Intel’s valuation is extremely low at current levels, not because Intel has bad fundamentals, but mainly because investors don’t want to own the stock due to the lack of visibility on what’s ahead and financial struggles pressuring management’s comeback plan under Pat Gelsinger. Intel had a rough year, down 54% since the start of the year, and recorded a sharp sell-off after this quarter’s results, news of fab delays in Germany and Poland, and the layoff notice. But all of this doesn’t change the fact that Intel is a legend in the semiconductor industry and still a dominant shareholder in the PC market with a 78.9% share of the Client PC market as of 2Q24, and, hence, should be valued at more than it is. Qualcomm is trying to steal Intel while it’s under pressure. We don’t think Qualcomm will pay three or four times for Intel, and we don’t think Intel will sell out of vulnerability; management certainly shows no signs of selling to begin with, let alone at current levels. There’s still a question about how Qualcomm, with $13B in cash on its books, would finance the bid for Intel, “valued at $122 billion, including its debt.”

This brings us to our second point: Qualcomm asking to buy doesn’t mean Intel is selling. The return of Gelsinger as CEO in 2021 marked the beginning of Intel’s comeback story – it’s not going great, but we don’t think there’s any question about the company’s survival. Intel isn’t going anywhere as long as the PC market exists, in our opinion. Intel management’s actions and commentary at the TMT conferences over this past month further confirm that the company is taking steps to better its positioning, whether in terms of CHIPS ACT funding or signing AWS as a foundry customer. Only a few days ago, Gelsinger sent employees a message on the “next phase of Intel’s transformation.” These are the actions of a company looking to stay, not sell.

Now, even if Intel wants to entertain the would-be-suitor, regulatory hurdles would prevent the deal from going through. Mainly the fact that Intel currently receives government funding from the CHIPS Act, noting that

CHIPS Act funding aims to increase U.S. semiconductor manufacturing and research and development capabilities, especially in leading-edge semiconductors.

Intel is tied to see this through with the funding in the pocket, and if Qualcomm buys Intel, that responsibility falls in its lap. Qualcomm, a fabless company that outsources its chips to TSMC (TSM), would have a foundry business with no expertise on how to operate it. If Qualcomm buys Intel, it’s gonna force the sale of the foundry business, but the only problem is that Intel’s foundry business is still in its infancy, i.e., it can’t stand alone and cannot be sold.

Additionally, the CHIPS ACT aims to “lure microchip manufacturing back to the United States after several decades of individual companies offshoring the technology”; while the U.S. used to produce ~40% of semi-supply in 1990, that number dropped to 12% with TSMC handling +60% of the share and 90% of the world’s advanced chips. So, the foundry business is to take part in the advanced node market to compete meaningfully with TSMC and achieve the goal set out by the CHIPS Act. This means Qualcomm would have to pour a lot of capital expenditure into it, and we don’t think Qualcomm can sustain the capex necessary for a fab. And, without such capex spending, the foundry business won’t generate money, i.e., won’t participate in advanced end, and the government won’t allow it, considering their funding and its goals.

The news doesn’t change our sentiment on either stock, but it does tell us that Qualcomm is getting audacious. Qualcomm is showing solid diversifying efforts amid weaker smartphone end demand, venturing into auto, PC, and IoT markets. Even during this period of muted end demand, Qualcomm’s position in the premium tier market has made it more resilient. The June quarter results and September quarter outlook outperformed mainly due to the diversification effort, with IoT and auto-related sales rebounding sequentially by 9% and 34%, respectively. However, we don’t think that the diversification legs will sustain meaningful outperformance in 2025 without a material rebound in the smartphone end demand. So, we recommend investors approach the stock with caution in 2H24 until that catalyst materializes.

Turning to Intel, we’re buy-rated on the stock, but only for longer-term investors. We specify longer-term investors because we believe Intel has a couple of near-term hurdles to overcome. With that in mind, while the valuation looks so bad today, we don’t think this is a fair valuation. There is no near-term catalyst at the moment, but we think the PC TAM could expand next year, as triggered by Microsoft Windows End of Life, and the adoption of AI PC could help support higher ASP, forming a positive for Intel’s PC business. We also think the start of rate cuts is a positive for Intel and the peer group because the economy will begin to expand again as the rates go down. There is a risk for Intel on the server front pertaining to the AI server cannibalizing compute server spend. However, even with AI servers, you need CPUs, so Intel has an in. We believe that it is a question of how much of that market Intel can grab with the competition between Intel’s x86 and ARM’s CPUs. Regarding the foundry business, we think the company will get some business as a secondary source rather than a primary one, and TSMC will hold on to the primary position. We still think Intel’s long-term comeback is intact, but we expect it to take time.

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