Framework Member Robert H. contacted me over the weekend asking about the Qualcomm QCOM / NXP NXPI merger. Regulatory bodies in seven countries have approved the merger. Now, only one country’s officials have yet to give the acquisition the official nod — China.
Observers believe that Chinese regulators may simply refrain from granting approval past Qualcomm’s offer deadline — Wednesday, July 25. If China does not grant approval and Qualcomm allows its offer to expire (as management has said it would), the deal would fall apart and Qualcomm would pay NXP a $2 billion break-up fee.
China is likely using its power of approval of the deal as a carrot to entice President Trump to rethink his plans to impose extensive tariffs on Chinese goods. If Trump does not take the carrot, Qualcomm and NXP will get the stick — a forced break-up of the deal.
You can read more about the background to this deal through the following articles:
- Is Qualcomm, NXP Deal Taking Its Last Breath? (247WallSt.com)
- Trump Tried to Protect Qualcomm. Now His Trade War May Be Hurting It. (NY Times)
Morgan Stanley’s Qualcomm analyst has publicly weighed in, suggesting that Qualcomm make its bid open-ended, so that it would not expire before China grants approval.
Robert reported that option prices on the firms are high due to the geopolitical uncertainty, and wondered what NXP’s shares might be worth if the deal falls through and Qualcomm has to pay the break-up fee.
Interested in Robert’s question, we took another look at NXP and revised our fair value range. A few things to note:
- We did not use the firm’s entire stated Depreciation and Amortization figure as an estimate of maintenance capital expenditures. We looked at the amortization charges and realized that they were mostly due to acquired research, so counting that as a deduction from profits would be double counting (because the firm already has an R&D expense…). If this adjustment is not warranted, our profitability assumptions are too high.
- In the years since its 2010 IPO, NXP has spent more on investments than it has taken in as profits. The deficit is entirely do to the company’s $11 billion acquisition of US chip manufacturer, Freescale, in 2015. Excluding that acquisition, the company has spent about 30% of its profits on investments. We ended up using an Investments as a percent of OCP value of 50% to try to incorporate the necessity of infrequent future acquisitions.
Making these assumptions, as well as the other operating assumptions you can see directly in the model itself, and adding $2 billion in break-up fees gave us an average fair value of six likely valuation scenarios of $104 / share — a few percent lower than its trading price today.
Have a look at my assumptions and see if they make sense to you. Let’s talk about this during this week’s Office Hours!