Qualcomm – Tooth and nail.

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This time around, Qualcomm should fight.

• I think Qualcomm will best serve its shareholders by fighting tooth and nail to halt the fall of royalty rates that has been going on for the last 9 years.
• The fight between Apple and Qualcomm is a sure indicator that life in the smartphone market is getting tougher which came to light in Qualcomm’s latest earnings release.
• FQ1 17A revenues / Adj-EPS were $6.0bn / $1.19 compared to consensus estimates of $6.11bn / $1.18.
• Guidance was very slightly weak with FQ2 17E revenues / Adj-EPS of $5.5bn – $6.3bn / $1.15 – $1.25 compared to consensus of $5.9bn / $1.19.
• Apple’s dispute with Qualcomm is nothing new and in fact from a brief examination of Apple’s complaint and Qualcomm’s response, it is clear that while times have changed, the arguments remain broadly the same.
• Between 2006 and 2008, Qualcomm was embroiled in a bloody and bitter fight with Nokia which at the time was in the same position that Apple finds itself today.
• At that time, Nokia made almost all of the mobile phone industry’s profits and so it was the largest payer of royalties to Qualcomm.
• When its contract expired, it sought to lower the rate it was paying to Qualcomm and when negotiation did not work it resorted to the courts.
• At the time, I believed that Qualcomm had the advantage and would eventually win but Qualcomm decided to settle with Nokia in 2008.
• Although the real details were not disclosed, I calculated at the time that this resulted in a new royalty rate of around 2.3% down from the old rate of 4.1% (of the wholesale price of the device).
• The problem with this is that everyone else was paying 4.1% and then went on to demand the same deal as Nokia.
• More recently, Qualcomm has done a deal with China where the effective rate appears to be around 1% which could very well a further decline in the overall global royalty rate that Qualcomm receives for its IP.
• This is the heart of the problem with patents as there is no real way to determine what should be paid to for them.
• I have long believed that patents are worth either:
  • First: what an entity is prepared to pay for them or
  • Second: the present value of the cash flows that the patent generates.
• This is why historical precedent is so important when it comes to patent licencing and here Qualcomm has a huge advantage.
• Qualcomm has hundreds of agreements and more than 20 years of history as evidence that its agreements have not damaged the mobile industry, in fact quite the reverse.
• The issue of course is that Apple simply wants a lower royalty rate and even the terms of the deal in China appear not to be low enough.
• Qualcomm claims Apple has rejected terms that are consistent with the deal it did in China and upon which it has struck most of its Chinese licences.
• The problem as I see it is that if Qualcomm gives Apple a discount then the rate paid by everyone will go down yet again and where it will end is impossible to tell.
• By fighting against Apple, it has a chance to arrest the general fall of royalty rates across the industry and stabilise them at what I would estimate will end up at around 1%.
• This is why Qualcomm must fight as I think that the future of its IP licensing business depends on it winning the second time around.
• It will be painful and expensive but I can’t see how Qualcomm has much choice.