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Is the Broadcom-Qualcomm Deal in Jeopardy? Winners & Losers

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In a rare intervention by the government, the U.S. Treasury's Committee on Foreign Investment in the United States (CFIUS) has outlined key concerns in a letter dated Mar 5, 2018 to both Broadcom Ltd. AVGO and Qualcomm Inc. QCOM related to their proposed merger deal. CFISU will closely review the deal and has asked Qualcomm to postpone shareholders' meeting for a month.

The decision of the regulatory body is unprecedented in view of the fact that Broadcom’s proposed $117 billion (net of debt) bid for a hostile takeover of Qualcomm has not been finalized so far. The decision of the secretive government panel reflects an aggressive position by the administration to protect major American corporate names from being acquired by non-U.S. entities.

Importantly, several U.S. tech giants have taken a stand on the deal. While Apple Inc. AAPL will be a beneficiary if the deal goes through, both Microsoft Corp. MSFT and Google of Alphabet Inc. GOOGL opposed the deal.

U.S. Treasury Raises Several Concerns

First, while Qualcomm is U.S. mobile chipset giant and a global leader for setting wireless standards, Broadcom is based in Singapore, notwithstanding the fact that the company expressed its desire in last November to shift its legal headquarter to the United States.

Second, Broadcom has a reputation of reducing R&D expenditures. Analysts have estimated that the company needs to raise more than $100 billion in debt to complete the proposed deal. Consequently, management may be tempted to cut R&D expenditures in order to service debt. Qualcomm generally spends more than 20% of its revenues on R&D every year.

Third, massive investment in R&D is an integral part of Qualcomm to maintain its global leadership position in the smarphone chipset market. Compromising Qualcomm's assets through arrangements with "third party foreign entities," will significantly affect national security of the United States.

The third party entities, especially, the Chinese tech giants like Huawei and ZTE may get access to Qualcomm’s precious patents from Broadcom or at least a stalled R&D activity may result in Qualcomm losing its competitive edge in the upcoming 5G wireless network standard to its Chinese counterparts. Qualcomm has issued and applied more than 130,000 patents primarily in smartphone areas.

Both Broadcom and Qualcomm currently carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Winners and Losers

If the Broadcom-Qualcomm deal sees light of the day, smartphone giant Apple may be a major beneficiary. Qualcomm which provides chipset for iPhone and iPAD is currently engaged in $1 billion legal battle related to royalty payment with Apple. But Broadcom expressed desire to resolve the litigation amicably if the deal goes through.

Meanwhile, Microsoft and Google of Alphabet have raised concern about the proposed merger. These two tech giants consider an independent Qualcomm as being more closely aligned with their interests than a Broadcom-owned Qualcomm.

For Google, most of the Android-based smartphones and tablets run on Qualcomm’s chipset. Consequently, a decline in chipset standard will be detrimental to Google. Similarly, Microsoft recently unveils first Windows 10 OS based PCs using Qualcomm’s chipset.

Telecom M&A to Become Tougher

The decision will have a strong bearing on the merger and acquisition (M&A) activities in the telecom space.

On one hand, President Trump has stated that he wants to do away with nearly 75% of all governmental regulations during his tenure. The telecom industry will be one of the major beneficiaries of this policy change. A new Federal Communications Commission (FCC), helmed by Ajit Pai, exercising lesser restrictions, certainly augurs well for the telecom industry.

On the other hand, a sheer protectionist strategy like national security reflects growing concern by Trump administration over the flurry of deals in the United States by foreign companies.

The government seems highly concerned about the fact that United States may lose its edge in areas like technology and telecom to China and other Asian countries. In recent months, CFIUS has blocked takeover deals of U.S. companies MoneyGram and Lattice Semiconductor by Chinese counterparts.

Importantly, In January 2018, security officials of Trump administration have considered the prospect of the government building its own 5G network to combat China’s economic and cyber threat.

Bottom Line

While the U.S. tech industry is divided about the potential impact of the Broadcom-Qualcomm deal, the U.S. government expressed severe concern about the potential risk of an unnamed actor, possibly Huawei, working through Broadcom to hurt U.S. national security.

While Apple stands to gain from the deal, Microsoft and Alphabet could lose out if it goes through. This explains their opposing stands on the issue even as the fate of this key deal hangs in the balance.

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