Qualcomm announced its fiscal year Q3 2015 earnings yesterday, and the news wasn’t particularly good. The company’s revenue fell by 14%, to $5.8 billion, operating income declined a massive 40% (to $1.2 billion from $2.1 billion), and net income fell by a billion dollars, to $1.2 billion. Most of these declines were caused by one-off payments or settlements — Qualcomm took a $142 million charge on its Mirasol display business, paid $975 million to the China National Development and Reform Commission, and paid another $950 million “to secure long-term capacity commitments at a supplier of our integrated circuit products.”

Now, it’s also true that Qualcomm lost Samsung’s business for its Snapdragon 810, and that did have an impact on the company’s bottom line, but the fact is, Samsung’s Galaxy S6 and Galaxy S6 Edge sales have been poor. Not only did the company overestimate the number of customers who would want an S6 as opposed to an S6 Edge, it didn’t raise production quotas for the S6 Edge. As a result, some of the people who wanted an Edge settled for a vanilla S6. The amount of money Qualcomm lost by losing Samsung’s sales, therefore, is smaller than you might think.

The rest of the drop-off can be explained by Qualcomm being caught off-guard by 64-bit SoCs. It had no custom architecture ready to deploy, and was forced to adopt ARM’s standard cores for its next-generation of chips. That left the company with less to offer as far as a concrete reason why manufacturers should choose a Qualcomm 20nm 810 or 808 against other chips from different manufacturers.

Qualcomm’s problems last quarter were caused by one-time payments, not a steep drop-off in product sales. While the company’s revenue fell by 14%, its operating income and net income fell by more than a billion dollars respectively. That degree of difference suggests that it was the one-time costs and prepayments for foundry space that caused the drop-offs, not continuing operations. The fact that Qualcomm shipped the same number of MSM chips and 15% more 3G/4G modems compared with last year also supports this analysis.

Cutting costs, exploring spinoffs

Last week, we heard rumors that Qualcomm was exploring spinning off its technology licensing division and its chip technology division. Those rumors have been proven true, in that Qualcomm is at least considering this move. It’s also laying off 15% of its workforce, cutting share-based compensation across the company by $300 million dollars, planning to reduce costs by $1.1 billion by aggressively “right-sizing” the business, and reducing the amount of money it spends on research and development.

These aggressive plans and fundamental changes are a bit strange given that much of the slump in operating revenue and net income were driven by one-time charges. The 14% drop in revenue is concerning, to be sure, but it’s also explainable. Samsung opted not to use Snapdragon 810 and the company has faced some price pressure from the low-end of the market, driven by companies like MediaTek and Rockchip.

There’s no good reason for Qualcomm to actually explore spinning off its chip designs — like AMD, the company product lines and its patent licensing are, at some level, critically tied to its ability to build new processors and research new technologies. There’s also no reason why a 14% drop in revenue should lead to slashing 15% of employees when the firm is experiencing some challenges — until, that is, you look at Qualcomm’s earning transcript and some of the supplemental documents it released yesterday.

Qualcomm conquered by the cult of shareholder value

There is a reason for these dramatic changes, but it’s not because Qualcomm had a down quarter. The company has been taken over by activist investors who are pushing the company to make changes and commit to stock buybacks that will boost the profits of institutional investors, even if those options harm Qualcomm’s ability to compete in the future. Qualcomm didn’t just release its financial statement yesterday — it included a secondary press release that spoke directly to this issue:

Qualcomm Incorporated (NASDAQ: QCOM) today announced it has initiated a Strategic Realignment Plan designed to improve execution, enhance financial performance and drive profitable growth as the Company works to create sustainable long-term value for stockholders. The Company also announced that it has entered into an agreement with JANA Partners pursuant to which Mark McLaughlin and

Tony Vinciquerra have been added to the Board of Directors and a third director to be selected by the Company and consented to by JANA will be added promptly.

The press release goes on to state that the core elements of Qualcomm’s new plan are as follows:

Aggressively right-sizing the cost structure by eliminating approximately $1.4 billion in spending, including an approximately $300 million reduction in annual share-based compensation grants; Company expects to achieve this run-rate by the end of fiscal year 2016

Reviewing alternatives to the Company’s corporate and financial structure

Reaffirming the Company’s plan to return significant capital to stockholders

Adding new Directors with complementary skills while reducing the average tenure of the Board of Directors

Further aligning executive compensation with performance, including returns on

investment

investment Disciplined investment in areas that further Qualcomm’s leadership positions, build upon the Company’s core technologies and capabilities and offer attractive growth opportunities and returns

These are changes that will benefit already-rich investors and investment banks, but offer zero improvement to Qualcomm as a business. To demonstrate the magnitude of the shift, I put together a graph of how many times the CEO of Qualcomm, Steven Mollenkopf, used certain words yesterday. Since this kind of comparison is meaningless without data from previous quarters, I went back and pulled the same data from Qualcomm’s FY Q2 2015 and FY Q1 2015 conference calls. Here are the totals:

In Q1 and Q2, Mollenkopf barely mentions stockholders or shareholders. In Q3, he references “stockholders” nearly two dozen times and uses the phrase “Stockholder value” or “Shareholder value” a combined 11 times. That number would be higher if we considered the number of times he uses the word “stockholder” and “value” in the same sentence — our graph doesn’t capture a sentence like “We pledge to increase our value and pay higher dividends to both stockholders and stakeholders.” In some places, Mollenkopf literally refers to creating stockholder value twice in the same paragraph.

The problem with the cult of shareholder value, meanwhile, is that there’s no evidence whatsoever that prioritizing returning capital to shareholders before considering the needs of consumers or the company’s own engineers is actually a good idea. The Washington Post published an excellent story on this topic, but much of it is common sense. A business that focuses on returning the maximum amount of money to shareholders isn’t focused on expanding its operations, performing additional R&D, or simply socking away some cash for hard times. The structure is reinforced by the expectations of Wall Street, which cares little for long-term planning, and by pay packages and compensation plans that pay executives based on the short-term performance of the stock, not the long-term ability to deliver growth or break into new markets.

The entire idea of breaking Qualcomm up into two companies, for example, makes no sense from an ongoing business perspective — but it makes great sense if you’re an investor who believes the real money is in patent licensing (an extremely high-margin business) and not in chip manufacturing. Cut off the low-margin chip business, and you trim Qualcomm into a patent holder who can then aggressively push other companies to license its technology without having its profits diluted by the cost of building chips. This would, of course, vastly complicate the relationship between the two sides of Qualcomm’s business and could result in the company losing its position as one of the largest powers in mobile, but that’s irrelevant to the cultists who see the potential for massive revenue from licensing fees.

Maximizing shareholder value has vastly increased inequality in America, by tying executive revenue to how much money they give back to the investment system, rather than how much they invest in their own employees and ongoing operations, or what the long-term impacts of their policies are over 3-5 years.

As recently as 1980, the average CEO in America made 29x more than the average worker at a plant. The cult of shareholder value got its start in late 1970s and its long-term impact has been profound. CEO pay peaked at 411x the pay of an average worker for that company in 2000, slumped dramatically thereafter, peaked again immediately before the Great Recession, and is now climbing again. In the conference call yesterday, Mollenkopf stated “We remain committed to returning at least 75% of free cash flow to stockholders through dividends and buybacks.”

That’s money Qualcomm could be using for R&D, facility expansion, or saving it against unexpected market shifts. Instead, they’ll be handing it over to the richest institutional investors, two of whom now sit directly on the Board, with a third appointment coming.

The near-term impact of these decisions shouldn’t be huge, these kinds of changes take years to come to fruition. In the long run, however, this kind of shareholder prioritization is unlikely to be good for the company or its customers. How can it be? Qualcomm just told the world, point-blank, that returning as much money as possible to a handful of already wealthy individuals and companies is more important than continuing to invest in its own hardware, technology, and personnel.