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Live by the Sword! Fall on Your Sword!

Qualcomm has always been a favorite among the fast money crowd, because the company fairly consistently exceeded estimates. If you look at the data over the past two-plus fiscal years you can see that, with few exceptions, Qualcomm’s reported pro forma ("as if") results were generally ahead of guidance. After a while the sell-side analysts begin factoring that into their forecasts, but for the most part, Qualcomm managed to deliver the much desired "upside."

The critical point is: Did the upside stem from stronger than expected operations or from some other source? As you can see in the table below, a substantial part of the company’s earnings per share derives from non-operating income (i.e., investment income).



As I have noted before, "pro forma" results have no definition according to Generally Accepted Accounting Principles (GAAP). Consequently, Company X’s pro forma results may be in no way comparable to Company Y’s pro forma results. What they all report to the Securities & Exchange Commission is GAAP.

So shifting to GAAP results for some comparisons, in the graph below you can see Qualcomm’s earnings per share from other income as well as its percentage of total GAAP earnings per share. What jumps out at you is that for the first half of that time-frame, Qualcomm was getting a fairly hefty percentage of its earnings from its investments rather that from its operations. The question for investors is, "Is this unusual?"

For comparison purposes, I looked at a few other prominent technology companies: Cisco Systems Inc. (Nasdaq: CSCO), Intel Corp. (Nasdaq: INTC), and Microsoft Corp. (Nasdaq: MSFT). Like Qualcomm, they have large amounts of cash and securities and generate a fair amount of cash from operations. As you can see in the table below, I have put them on equal footings (calendar year comparisons) for the last two years.



During 2007, Qualcomm generated substantially more of its GAAP earnings per share than did the other three firms. With the deterioration of the markets in late 2008, the other income contributions for Qualcomm and Intel both generated significant losses, so they ended up being a drag on earnings for 2008.

This raises the question of why the company generates so much more investment income.

The quick answer to that is: It depends on what you invest your cash in. As all investors have come to realize, everything has a risk profile. Cash in your mattress is pretty riskless if you exclude the potential for theft, fire, or some other disaster, but it earns nothing sitting there. Buying a government bond is fairly conservative, depending upon the government. Obviously there is a flip side to the risk equation of every investment, and that’s reward. Generally speaking, the higher the risk, the higher the reward, and that appears to be the answer to Qualcomm’s other income.

In the company’s recently filed 10-Q for the December quarter, Qualcomm identified its marketable securities positions. As you can see in the graphic below, the company has approximately $5.2 billion in marketable securities. Of that total, a whopping 42 percent fall into three categories: non-investment-grade debt; equities; and mutual funds and exchange traded funds. None of these is what you would call "low risk." Of equal importance is that, as of December 31, Qualcomm has unrealized losses of nearly $900 million on these investments. Those are losses that it has yet to run through its P&L, like the $294 million it had to recognize in the December quarter, as they were deemed to be "other-than-temporary." The company’s management intends to hold on to these investments with the expectation they’ll recover their value. They may, but when? You can’t sit with unrealized losses indefinitely.

To be fair, I’m not suggesting that Qualcomm’s treasury operations are doing anything wrong. There are plenty of companies that adopt a more aggressive approach toward their investments. But investors need to take a hard look at where earnings are coming from and why. If it’s too good to be true, there may well be a downside you’re not seeing in the good times.

— Bob Faulkner, Special to Unstrung

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paolo.franzoi 12/5/2012 | 4:12:45 PM
re: Live by the Sword! Fall on Your Sword!
I like the discussion of balance sheet cash. However, I would like to extend the discussion. You mention the risk versus reward issues. What you fail to mention is the "Who is making the decision?" issue?.

Firms with huge amounts of cash are running cash investment operations. The alternative is to return this spare cash to investors to allow them to invest it as they see fit. There are 2 basic ways of doing this: Share Buybacks and Dividends (including 1 time special dividends). One might debate whether using this cash for additional investments - like buying companies - could count as well. I would generally say yes. But why the heck are companies sitting on barrels of cash that they are not using? I can think of several good answers, but I think we are way beyond the need for the cash to run the business in many of these cases.

Really - if you are an investor - do you want Qualcomm (as this example has) investing your money?

seven
renkluaf 12/5/2012 | 4:12:40 PM
re: Live by the Sword! Fall on Your Sword! Brookseven,

Generally the CEO & CFO set the strategy for cash investments and that is executed by the Treasurer. Traditionally, tech firms have hoarded cash to support their higher growth rates but that has changed somewhat in the last 5-10 years as the growth has mitigated. Cash management is also a very emotional issue just like it is with individuals. In a downturn, as now, we want to hold as much as possible out of fear of the unknown and the reverse is true during up turns. It's always tough to know how much cash is enough because, as you suggest, you can't know when an acquisition opportunity may become available nor can you predict when events may send a positive cash flow into the red.
paolo.franzoi 12/5/2012 | 4:12:39 PM
re: Live by the Sword! Fall on Your Sword!
RMF7155,

I am quite aware of how cash management works in companies. However, it is still not the place of a company to become an investor - except to manage its needed cash.

Companies like Microsoft, Cisco - heck all the listed ones in this article - have much more cash than they require to execute their businesses. Most of their acquisitions are stock based and do not require cash at all. So, I stand by my statement that they should give a significant amount of their cash back to shareholders. These shareholders can then choose what to do with their cash - bonds, CDs, invest in other firms, etc. But I don't pay a CFO or a treasurer to be an investor. That is MY job not theirs.

So, either use it or give it back. It is not yours to keep and invest in low return safe securities. If I want to do that, it is my prerogative. If I want to take more risk, that is my choice as well.

seven
lrmobile_Ziggy 12/5/2012 | 4:12:33 PM
re: Live by the Sword! Fall on Your Sword! I'm not sure if this is the right forum to discuss investments, but I generally agree with Mr. Seven. When I invest in a company like Qualcomm, I invest in the chip vendor / patent licensing company, not in a mutual fund trying to diversify its investments. Having enough cash to acquire companies allowing them to grow their business is desirable. Having so much cash that their short-term investments have a mterial impact on their financials is not.

If I want to diversify my protfolio, I'd rather do it myself. Imho, publicly-traded companies should concentrate on growing their core businesses, rather than trying to reduce thei risks at all costs.