With an offer of 70$ per share totalling 103B$, Broadcom has initiated a discussion of the current value of Qualcomm. The share price of Qualcomm prior to the bid was floating around 53$ suggesting a market value of 79B$. The Broadcom bid has increased the value of Qualcomm’s share price in the vicinity of 64$ (95B$) suggesting the investor view is mixed about the probability of a merger.
The immediate response from Qualcomm to the offer of 70$ was that it was undervaluing the corporation. So who is right? How do you calculate the value of a corporation?
Calculating what a company is worth requires a view of the current financial state of the company and assumptions about the company’s future.
Shareholder Value Analysis (SVA)
An effective way of calculating corporate value without being a CFO is to create an SVA analysis. An SVA calculates the value based on a company’s ability to generate future cash flows. Because of the time value of money, the cash flows are discounted with the Weighted Average Cost of Capital (WACC). Don’t worry – you don’t need to understand WACC or discounting to read the rest of the article. All you need to know is that WACC for the semiconductor industry is approx 9.2% at the moment and that it can change over time. It can be seen as the minimum acceptable rate of return investors in semiconductor companies will accept.
There are 7 value drivers that impact the future cash flows of a company in which Revenue growth and operating margins are most important for valuation of a fabless semiconductor company.
An assumption that satisfies the Broadcom bid can be seen below:
You don’t need to understand all of the technicalities of the calculation other than the Yellow box represent the value in m$ and in share price, based on the assumptions above. The sensitivity analysis lower left shows that the value of Qualcomm is impacted most by Operating Margin and Sales Growth Rate.
Operating Margin: In this example, 25% is chosen. Since the beginning of 2016, Qualcomm’s OPM has varied between 5.6% and 41%. The most recent was 5.6% showing Qualcomm’s dependence on license payments from their customers.
Sales Growth Rate: The latest quarter Qualcomm experienced -4% growth compared to the same quarter last year. This was again impacted by low license payments from customers based on legal disputes. In the example, 7.3% is chosen to satisfy the 70$ bid.
In other words – Qualcomm is worth 70$ if it can maintain an OPM of 25% and a Sales growth rate of 7.3%.
Value at 25% OPM
Real business nerds (yes we are) would immediately try and find out what different Sales Growth Rates would do to the valuation of the Qualcomm:
The chart shows (Assuming 25% OPM) that the market estimated that Qualcomm was able to grow sales 2.5% per year. The Broadcom offer would balance if Qualcomm was able to achieve 7.3% sales growth per year.
It is also possible to investigate Operating Margins impact on Qualcomm valuation. If the assumption is made that Qualcomm will be able to achieve an average sales growth rate of 7.3% the impact of various Operating Profit Margins can be evaluated.
The prebid valuation shows it could be achieved at 18.5% OPM and that the current Broadcom offer balances at 25% operating margin.
It is important to understand that for Semiconductor companies with most of the value tied up in intangible assets, a discussion about value is a discussion about expectations about the future. When Qualcomm states that the Broadcom undervalues the company it is really a discussion about two different views about the future.
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