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Qualcomm comes out fighting, rejecting Broadcom and adding Chinese deals

Qualcomm is coming out fighting, as everyone would expect from the bruising San Diego chip provider. It has rejected Broadcom’s $103bn takeover offer (plus $25bn debt), which could now go hostile, or spark a bidding war.

And the rejection was accompanied by a string of announcements which highlighted the strengths Qualcomm still has, despite its legal and competitive battles – strengths which could still enable it to remain independent. The company touted a string of deals signed with customers in China – the source of many of its woes in recent years; as well as the commercial shipment of its first server processor, designed to open up new markets in data centers and cloud platforms; and the promise of a “monumental” 5G New Radio announcement with ZTE and China Mobile (due later this week).

All this seemed to signify, in terms of public image at least, a company which had bounced back from the rather fatalistic outlook that hung over its most recent quarterly results, hit badly by the ongoing dispute with Apple and subsequent suspension of royalties; and over the reaction to the Broadcom bid. While some Qualcomm supporters and investors hoped it would roundly spurn the offer, in fact the US company was muted in its response and just said it would evaluate the bid.

Now, though, it is recommending that its shareholders reject the offer, saying it is too low; it is likely to face strong regulatory scrutiny; and it represents an opportunistic move to acquire valuable assets on the cheap by Broadcom – which has moved its headquarters from Singapore to the US, presumably to facilitate US takeovers like that of Qualcomm and Brocade.

“It is the Board’s unanimous belief that Broadcom’s proposal significantly undervalues Qualcomm relative to the company’s leadership position in mobile technology and our future growth prospects,” said Paul Jacobs, executive chairman and chairman of the board, in a statement.

Broadcom, which had previously indicated it was willing to “go hostile” on the acquisition attempt, responded that it remained “fully committed” to the deal. So it may now initiate a proxy battle, in which it appeals directly to shareholders despite the opposition of the company board, but that would likely involve a higher offer, and a protracted and emotional process which would risk distracting both companies from the business in hand, and from meeting the challenges of an increasingly competitive chip industry, with the emergence of Chinese players, in particular, sparking a wave of consolidation.

Broadcom chairman Hock Tan said he was encouraged by the response so far from Qualcomm shareholders and customers and would aim to keep the negotiations “friendly”. He said in a statement: “We have received positive feedback from key customers about this combination. We continue to believe our proposal represents the most attractive, value-enhancing alternative available to Qualcomm stockholders and we are encouraged by their reaction.”

Qualcomm shares rose by 2.2% to $65.96 on Monday on news of the rejection. Since the offer was made, they have traded below the bid price, indicating lukewarm investor reaction and doubts that the deal would pass antitrust scrutiny.

Broadcom has shown the scale of its ambition with this attempt – buying Qualcomm would turn it into the world’s third largest semiconductor firm, after Intel and Samsung. It also indicates the depth of consolidation which is affecting this business amidst profound changes in technology and competitive landscape. But the deal looks all wrong for Qualcomm and for the wider mobile chip industry. Despite its faults, the US company is still the leader in innovation and R&D investment in the mobile silicon world, and it is by no means clear that Broadcom, which has no such heritage, would make the same contribution to pushing cellular technology forward.

The initial muted reaction to the bid raised fears that Qualcomm would accept the offer as a panic reaction to the crisis over its licensing business model – which has been the foundation of its success and differentiation for so long, but is now under intense pressure from regulators round the world and from key customers like Apple. However, the company has many assets still, and while a radical rethink of its model seems inevitable, its market position in its core sectors could still enable that to be carried out as an independent entity.

However, many shareholders may take a less strategic view, and Qualcomm’s management will have a tough challenge to convince them that it can deliver more value as an independent, especially with the future of its own $38bn acquisition of NXP in doubt. Some analysts think that, if Broadcom is prepared to raise its bid to around $80 to $85 a share, the majority would accept. “Qualcomm shareholders are likely to hold out for more, but we believe something in the $80-ish range is likely enough to bring most of them around,” Stacy Rasgon, an analyst at Sanford C. Bernstein, wrote in a client note.

Qualcomm’s management team, led by CEO Steve Mollenkopf, will throw everything at the argument that the firm is more valuable on its own. It is already talking up its potential leadership in 5G, its huge market share in modems, it growth in core areas such as the cloud servers, edge computing and the Internet of Things (especially if it does secure NXP, though Broadcom says it wants Qualcomm with or without the Dutch firm).

Its announcement about availability of its Centriq server platform (see separate item) was timely to reinforce these points, as was the news that it had signed component deals valued at $12bn over three years, with three Chinese smartphone makers.

The agreements, with rapidly growing phonemakers Xiaomi, Oppo and Vivo, were signed on the sidelines of US president Donald Trump’s state visit to Beijing last week, said Qualcomm.

The firm will hope the news will draw a line under its recent rocky relationship with Chinese customers and authorities, since it makes more than half its revenues in the country. Its finances in 2014 were hit hard by a Chinese antitrust investigation of its business practices, which also resulted in many customers there withholding royalty payments, This was settled in February 2015, and the $975m fine Qualcomm paid was seen as a worthwhile investment, given the market’s importance. However, it took another year for royalties to start to flow properly again. In addition, many new competitors for Qualcomm’s market come from China, though the US firm has counteracted that to some extent by forming joint ventures with Chinese companies (which so far lack its level of engineering expertise in cellular technology), investing in local start-ups, and transferring some manufacturing to Chinese foundries

Despite all these steps forward, the trio of new deals will be very welcome news. The three companies signed memorandums of understanding with Qualcomm CEO Steve Mollenkopf at a ceremony at the Great Hall of the People in Beijing, led by Chinese president Xi Jinping and Trump. Mollenkopf was part of Trump’s Department of Commerce Trade Delegation to China.

The CEO said Qualcomm had longstanding relationships with Xiaomi, Oppo and Vivo, which had now been expanded, and that “we are continuing our commitment to investing and helping advance China’s mobile and semiconductor industries”.

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