The past week saw quite a few developments in the mobile sector. Nokia’s (NYSE:NOK) tax dispute with Indian authorities continued, as the Supreme Court upheld a lower court order seeking to block the transfer of its local assets to Microsoft (NASDAQ:MSFT) until it submitted a $570 million guarantee to cover its tax liabilities. Apple (NASDAQ:AAPL) launched a cheaper version of the iPhone 5C in certain European and Asian markets to take advantage of the growing mid-tier smartphone segment in regions where LTE adoption is still in in its infancy. Qualcomm (NASDAQ:QCOM) received a boost from China Mobile’s (NYSE:CHL) decision to sell only five-mode LTE handsets from June onwards, which should not only increase orders for its more mature five-mode basebands but also lead to higher royalty fees from Chinese OEMs going forward.
Nokia’s Liabilities Limited In Indian Tax Row
Nokia suffered a setback in its Indian tax case last week, as the Supreme Court rejected its appeal against a lower court order which had directed the company to submit an additional guarantee of $570 million before transferring its local assets to Microsoft. The handset maker is willing to deposit around $370 million in an escrow account to cover its tax liabilities, but the Indian IT (Income Tax) department believes that the amount isn’t enough to meet its tax claims, which range between $650 million and $3.4 billion. With the Supreme Court upholding the IT department’s demands, Nokia will weigh its options which include either fronting up the extra cash as a guarantee or shutting down its handset manufacturing plant altogether. The Chennai factory is one of Nokia’s largest globally, employing around 8,000 people and constituting about 25 percent of the workforce that will be transferred to Microsoft as part of the handset division sale.
However, the good news for Nokia is that it is not liable for its subsidiary’s (Nokia India Pvt Ltd.) liabilities, with the Supreme court ruling that the IT department can’t force the parent company to submit an assurance. This limits Nokia’s exposure to the extent of the value of its Indian assets, which it claims to be in the range of $440-$500 million and is probably what Microsoft is paying it for the asset as part of the $7.2 billion deal. If the tax dispute isn’t resolved soon or negotiations with local authorities do not bring its tax liabilities down to below $500 million, it might be in Nokia’s best interests to walk out of India without transferring its assets to Microsoft. This will give Nokia less than expected cash from the Microsoft deal, but limit legal distractions while not hitting its overall valuation by much. By our estimates, Nokia’s stock is worth about $28 billion and a $500 million hit due to the Indian tax dispute would cause its valuation to drop by less than 2% (see Nokia Loses Supreme Court Appeal In Indian Tax Dispute But Faces Limited Liabilities).
Apple’s Geographic Differentiation
In a somewhat surprising move, Apple rolled out a cheaper version of the iPhone 5C in certain European and Asian markets Tuesday. The new smartphone is not very different from the existing iPhone 5C models as far as specifications go, but at 8GB, it has half the memory capacity of the previous entry-level 16GB variant. This could be a restricting factor for many smartphone users given the ever-rising memory requirements for downloading new apps and movies. The device is therefore likely to be positioned as an on-ramp for first-time smartphone buyers looking to enter the iOS ecosystem. The 8GB variant has been launched only in the U.K., France, Germany, Australia and China, showing Apple’s intent to target those markets where 4G LTE is either being introduced or is only in the initial stages of adoption.
The new product launch points to Apple’s newfound strategy of differentiating its product offerings according to geographies. In recent months, Apple has reintroduced the iPhone 4 in India at a price point of roughly $350 to be able to compete better in the fast-growing mid-tier segment. It has also continued to sell the same model in China, at about 20% cheaper than the 4S, despite discontinuing it everywhere else. That the U.S. isn’t one of the initial launch markets for the 8GB iPhone 5C indicates that the company doesn’t see the lower-memory option as particularly valuable to buyers there, given the higher proliferation of LTE handsets in the country. This marketing strategy should help Apple better tap growth opportunities in markets outside the U.S., where carriers are looking to increase penetration of LTE as well as smartphones (see Apple Introduces Cheaper iPhone 5C Targeting LTE Growth In International Markets).
Advantage Qualcomm: Chinese Five-Mode Adoption
Confirming earlier rumors, China Mobile announced recently that it will sell only five-mode 4G handsets from June onwards. This puts an end to a brief adjustment period for local players when they were allowed to ship three-mode handsets to carriers as they looked to catch up with the more advanced five-mode technology. While five-mode 4G terminals provide global support for TD-LTE, FDD-LTE, TD-SCDMA, WCDMA and GSM, three mode leaves out WCDMA and FDD-LTE, making them more suited for domestic use on China Mobile’s network. Qualcomm, which is the industry leader in LTE baseband shipments and has the most mature and widely used portfolio of five-mode chipsets, should benefit from a near-term spurt in baseband demand from China Mobile as local players ramp up five-mode production. More importantly, it removes the risk of three-mode usurping five-mode as the more widely sourced standard at China Mobile, making it easier for Qualcomm to collect royalties on handsets that support global standards.
Given the higher margins on offer, mobile royalties are more valuable to Qualcomm than chipset sales. By our estimates, royalty income contributes over 45% to Qualcomm’s value as compared to about 27% that it derives from chipset sales. Although the reinstatement of the five-mode requirement by China Mobile lifts some of the uncertainty around Qualcomm’s future growth in China, there is still a significant concern that Chinese government’s anti-monopoly probe against the company could lead to lower royalty rates going forward (see Qualcomm To See Near-Term LTE Market Share Gains in China But Regulatory Uncertainties Remain).