Qualcomm, Chips Surge As U.S. Seen Pushing for Chinese Concessions

Trade is back in the news, with President Donald Trump tweeting over the weekend that he’s working to get China's ZTE "back into business" following U.S. sanctions.

The immediate impact is a big boost to U.S. semiconductor shares, but it could benefit other players in tech, depending on how things play out.

Chip shares are upbeat because numerous companies that were suppliers to ZTE, or potential suppliers, now see the prospect of having restrictions lifted on selling to the telecom equipment and smartphone maker.

Those shares include chip giant Qualcomm (QCOM), and NXP Semiconductors (NXPI), which it is in the process of buying; along with chip makers Integrated Device (IDTI), Pixelworks(PXLW), and Synaptics (SYNA); fiber-optic component vendors such as Neophotonics(NPTN) and Acacia Communications (ACIA), and perhaps even tech giants such as Intel (INTC) and Microsoft (MSFT).

Last month the U.S. Department of Commerce said it would block sales to ZTE by U.S. companies of components, after ZTE was deemed to have violated conditions placed on it with respect to prior violations of sanctions on Iran.

Over the weekend, reports MarketWatch's Dan Strumpf, Trump tweeted that the Commerce Department is reviewing ZTE’s request for a stay of the order, adding that Commerce has been "instructed to 'get it done.’"

Benefits could go beyond just semiconductor companies, some believe.

The goal of this latest move, according to Jefferies & Co.’s analyst Edison Lee, is "to obtain tangible concessions by China."

The Trump administration, he believes, doesn’t really want to risk a "total cut-off in tech trade between the two countries, which could cost U.S. tech firms an estimated US$100-150bn of annual revenue."

What could those concessions be?

They could include things like protecting intellectual property such as Microsoft’s (MSFT)Windows operating system, and also changing the exploitive joint venture terms that China imposes on U.S. companies partnering in the region.

"Media reports suggested that Microsoft increasingly gave up the hope of generating licensing revenue on Windows in China, but hopes to generate revenue from Windows Office licensing by giving out Windows 10 for free,” notes Lee.

"We believe this will be one potential area of concessions by China, which means much stricter software IPR enforcement, and elimination of local JV requirement in certain services."

"Furthermore, we believe the across-the-board tax concessions (zero to 15%) for tech firms in China could be at risk. "

Two immediate beneficiaries are Qualcomm and NXP: Their merger has been ongoing for over a year, with Chinese regulators having been the final holdup. Qualcomm was forced to refile its application for approval to China’s MOFCOM last month.

Trumps tweets over the weekend appear to have prompted Chinese authorities to re-open their review of Qualcomm deal. The result: Qualcomm shares are up $1.53, or 2.8%, at $56.76, while NXP is up $9.30, or almost 10%, at $108.31.

Amit Daryanani of RBC Capital reiterates an Outperform rating on Qualcomm, writing that the stock is “an interesting name for value investors, as either NXPI deal gets done or Qualcomm does a sizable buyback."

He’s referring to Qualcomm’s CEO Steve Mollenkopf’s stating in January that if the NXP deal falls apart, Qualcomm will buy back as much as one third of its shares.

Stacy Rasgon of Bernstein, who has a Market Perform on both stocks, writes that there could be "a near-term trade opportunity” as deal hopes improve, but he actually thinks Qualcomm would be better off just doing the giant buyback and not doing the NXP deal.

Other beneficiaries include Acacia and Neophotonics, according to Rosenblatt’s Jun Zhang. He sees a bounce back in orders for Acacia, and some benefit to both Neophotonics and Oclaro (OCLR):

If the ban on ZTE is lifted in June, it would require ZTE to aggressively buy components from suppliers and China telecom operators in order to regain market share. Acacia is likely to be benefit in the near-term […] ZTE also largely orders EML lasers from NeoPhotonics’ (NPTN: Buy) for its 5G front haul PAM4 solution […] We believe ZTE could account for approximately 5% of NeoPhotonics’ business in 2H18 […] We believe Oclaro still has some arbitrage opportunity if ZTE’s business resumes, and would expect that if this scenario plays out that Lumentum’s acquisition of Oclaro would likely occur.

And then there’s a gaggle of other names that could benefit, according to Dougherty & Co.’s Charles Anderson, including IDT, PIxelworks and Synaptics:

[IDT] management disclosed last quarter that ZTE in FY18 represented $20MM of annual revenue to IDTI and that they have pulled it out of their go-forward forecast entirely. We note that adding back ZTE revenue would allow IDTI to update its margin model to 30%+ operating margins […] We believe PXLW was set to ship its Iris chipset to ZTE for incorporation into two smartphones this year, one in June and one in September. By not being able to ship to ZTE, we believe PXLW lost out on ~$1M/Q of revenue [...] Management messaged last week that it was negatively impacted by the ZTE ban, but did not give an amount. We note ZTE was one of the customers SYNA was targeting for its in-display fingerprint sensor.