Another reason Qualcomm shouldn't buy Intel? Its bonds could reach junk status.

By Ciara Linnane

GimmeCredit started coverage of Qualcomm's bonds Wednesday with a bearish rating

An earlier version of this article incorrectly said bonds were being bought, not sold. It has been corrected.

Equity analysts are skeptical about the merits of a possible combination of Qualcomm Inc. and Intel Corp., after a recent report said the former had approached the latter about a takeover.

On Wednesday, credit-focused analyst Dave Novosel of Gimme Credit added his voice to the concerns about a deal, noting it would likely require a combination of equity and debt that would send leverage for Qualcomm (QCOM) into junk-bond territory.

Qualcomm has more than $14 billion of outstanding bonds, which carry an A rating from S&P Global Ratings, according to FactSet. Intel (INTC) has more than $50 billion worth rated at BBB+, after an August downgrade made on concerns about weak near-term growth prospects and margin compression.

A huge equity portion would lead to substantial dilution for shareholders, Novosel wrote. A downgrade to junk would increase Qualcomm's interest costs and cut it out of a wider pool of investors such as pension funds that can only invest in investment-grade debt.

Novosel initiated coverage of Qualcomm's bonds with an underperform rating, noting the company's 2033 notes are trading at a yield spread of 50 basis points over Treasurys.

"While we do not see the completion of an Intel transaction aslikely, we are concerned that Qualcomm would consider such an undertaking," the analyst wrote. "Its dependence on Apple is another concern."

Intel declined to comment Friday on a report in the Wall Street Journal discussing Qualcomm's takeover overture, while Qualcomm didn't reply to a MarketWatch request for comment.

Novosel acknowledged some benefits of a deal, such as Intel's strength in PCs and servers for data centers, which would complement Qualcomm's mix of smartphone business, as handsets account for more than 70% of total revenue.

"It would lessen Qualcomm's reliance on Apple (AAPL) for a significant portion of its revenue," he wrote. "In addition to the revenue synergies wewould expect meaningful cost synergies from a deal, particularly with respect to administrative functions."

From an investment standpoint, the slide in Intel's stock price-it's down 52% in the year to date-has cut its market cap to only half that of Qualcomm, he wrote.

"However, any bid would likely include a takeover premium,bringing the value to more than $100 billion," said Novosel, requiring high levels of debt and equity to pull off.

Intel is already highly levered thanks to its investment to finance the expansion of fabrication plants. Meanwhile, revenue declines and operating losses in the foundry business have weighed on Ebitda, or earnings before interest, taxes, depreciation and amortization, a metric often used as a measurement of a company's ability to cover its interest costs.

"Buying Intel would crush Qualcomm's margins considering that Intel has posted negative operating income in eight of the last nine quarters, partly due to the ramping of new products," said the analyst. "Admittedly, that streak of losses is not likely to last much longer. Moreover, free cash flow would likely turn negative when including Intel because of the outsized capital spending."

Like equity analysts, Novosel is not expecting Qualcomm to have much interest in the foundry business, as it relies heavily on Taiwan Semiconductor (TW:2330) and Samsung (KR:005930) for its chips.

But spinning it off at a time when the unit is still posting sharp losses would be challenging, while the U.S. government may be irked given the cash Intel has received to bolster chip production in the U.S.

Qualcomm can also expect close regulatory scrutiny, given the size and scale of the two companies. Several large semiconductor deals such as Broadcom's (AVGO) attempt to buy Qualcomm and Qualcomm's attempt to buy NXP (NXPI) have been rejected.

"We think a better option for Qualcomm would be to pursue certain segments from Intel rather than the whole company. Unfortunately, the most attractive units would be those that Intel is counting on to deliver growth," said the report.

The bond market may not be convinced about a deal either, as the following charts from data solutions provider BondCliQ Media Services show.

Both names have seen net selling since the WSJ report, with Intel leading the way as it's the more liquid name.

Spreads, meanwhile, have actually tightened, although that's more a feature of strong credit markets than enthusiasm for a deal.

The next chart shows that Intel has nearly three times as many bonds outstanding as Qualcomm.

Qualcomm's stock is down 4% in the month to date. Intel's stock is up 16%.

Read now: Why Boeing's bonds are a hot item right now, unlike its stock

-Ciara Linnane

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09-25-24 1224ET

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