(Note: The author of this fundamental analysis is a financial writer and portfolio manager. He and his clients own shares of NXPI.)
Options traders are betting that Broadcom Ltd. (AVGO) and its CEO Hock Tan will not succeed in the company's proposed $120 billion attempts to acquire Qualcomm Inc. (QCOM). Broadcom pursued Qualcomm in November 2017 when it proposed a takeover of Qualcomm valuing the company at $70 per share. But when Qualcomm rejected the offer, Broadcom aggressively came back in February 2018, making a best and final offer for Qualcomm at $82.
Qualcomm stock closed at $54.84 on November 2, the day before word broke out about the first offer from Broadcom. The new, revised $82 proposal represents a 50 percent premium to Qualcomm's closing price on November 2.
But options traders do not see a deal between the two chip giants getting completed based on the options set to expire in June. Some are even betting that Qualcomm's stock will decline by 10 percent to nearly $60, based on its closing price of $65.66 on February 12.
The long straddle options strategy set to expire on June 15 is pricing in a rise or fall in Qualcomm's stock price of nearly 15 percent from the $65 strike price, putting the stock in a trading range of $55 to $75. The cost to buy one put and one call is $9.65. But more interesting is the open interest, which heavily favors the puts over the calls by a ratio of almost 2 to 1.
The $65 puts have nearly 28,000 contracts of open interest, representing a notional value of approximately of $13.2 million, a significant bet. Because the $65 puts cost roughly $4.85, a buyer of those puts would need to see the price of Qualcomm stock drop to roughly $60 for the options to break even.
The calls, by comparison, have about 15,400 contracts of open interest and are worth only $7.3 million. This suggests that more traders are looking for the price of Qualcomm stock to decline by June, not rise.
Do Not See A Deal
The $75 calls trade at roughly $1.00, and have an open interest of 25,100 contracts. That's a value of $2.5 million, a small wager.
This suggests that most option traders do not expect a deal with Broadcom to be completed. This is because if Qualcomm did accept Broadcom's $82-a-share offer, those options would have an intrinsic value of $7. That's merely the difference between the proposal price and the strike price, for a profit of $6 per contract. But the number of calls that are open at the strike price is small, indicating few see the stock rising above $76.
Qualcomm's Struggles To Continue
Qualcomm's outlook appears bleak, with analysts currently projecting revenue in 2018 to decline by nearly 4.5 percent, while earnings are expected to fall by almost 20 percent.
In 2017, Qualcomm had revenue of $23.24 billion, and analysts are looking for revenue of $22.18 billion in 2018, and $22.81 billion in 2019. Qualcomm's revenue peaked in 2014, when it reached $26.49 billion. A merger between Qualcomm and Broadcom would end Qualcomm's struggles and likely end its legal battle with Apple. (See also: Qualcomm's Feud With Apple Now Ropes in Intel.)
QCOM Revenue (TTM) data by YCharts
Whether the two companies will end up merging is the big question. A shareholder vote is set for March 6, and Broadcom is nominating 6 members to Qualcomm's board. But for now, the options market is saying a deal is not likely to happen.
Michael Kramer is the Founder of Mott Capital Management LLC, a registered investment adviser, and the manager of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Click here for Kramer's bio and his portfolio's holdings. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future performance.