Shares of Qualcomm (NASDAQ: QCOM) are in rally mode. Qualcomm stock is up 35% this year, and got an extra boost when several financial media outlets including The Wall Street Journal reported that the company is in talks to acquire NXP Semiconductors (NASDAQ: NXP). A deal could reportedly take place within the next two to three months.
This would be a huge acquisition, possibly worth more than $30 billion. That much money might make Qualcomm shareholders wince. But the good news is that there are clear and compelling catalysts in the potential deal that would make it a great move on Qualcomm’s part.
Why Acquiring NXP Makes Great Sense
NXP, like Qualcomm, is a major semiconductor manufacturer. It produces a wide range of products, including processors, microcontrollers, transistors and power management solutions. Its products are used across several industry applications. The most promising applications are growth areas of the future such as the Internet of Things (IoT), autonomous vehicles like self-driving cars and unmanned aerial vehicles like drones.
Not only would buying NXP help diversify Qualcomm’s product offerings, it would produce significant synergy benefits as well. Qualcomm would likely be able to eliminated duplicate functions, specifically in research and development and sales. And, Qualcomm’s enhanced scale would likely lead to additional pricing power.
NXP would be an ideal fit for Qualcomm because the companies have similar growth initiatives. Qualcomm has specifically targeted the IoT and connectivity as two of its main growth engines going forward. Rather than pursue years of costly internal investment, buying NXP would be an instant boost to its ambitions in these areas.
Financially, the deal makes total sense. Like many large-cap tech companies, Qualcomm enjoys the benefit of high profit margins and robust free cash flow. Qualcomm’s earnings per share grew 8.3% over the first three fiscal quarters of the year, as compared with the same period last fiscal year.
Qualcomm’s cash flow is piling up on the balance sheet. The company ended last quarter with $31 billion in cash, short-term investments, and marketable securities. With interest rates still sitting near historic lows, all this cash on the books is earning little to nothing for investors. Plus, a huge chunk of Qualcomm’s cash is held offshore. If the company were to bring that cash back to the U.S., it would face a significant repatriation tax.
Rather than have that money continue to burn a hole in Qualcomm’s pockets, or pay 35% to Uncle Sam to bring that cash back home, the company is making a savvy move to deploy that cash in a productive asset that will prove accretive to its long-term earnings growth.
Keep Holding Qualcomm Stock
Going forward, there are plenty of reasons for investors to stick with Qualcomm stock, in addition to the potential NXP acquisition. First, there is significant potential growth in 2017 and beyond due to organic investments in the Internet of Things and impending rollout of 5G and other advanced wireless technologies. This is likely to boost demand for Qualcomm’s chipsets.
Plus, even though Qualcomm stock has rallied in 2016, it is still modestly valued. Analysts on average currently expect Qualcomm to earn $4.03 per share in fiscal 2017. Based on its current share price, the stock trades for approximately 16 times forward consensus EPS estimates. That is a fairly cheap valuation for a growth stock.
In addition, Qualcomm pays a solid 3% dividend yield and has a track record of dividend growth. The company raised its dividend by a healthy 10% this year.
As a result, Qualcomm stock has something to offer growth, value, and income investors alike.
Disclosure: The author is personally long QCOM.