Factors That Cast Uncertainty Around Qualcomm’s China Operations

Leading mobile chipmaker  Qualcomm (NASDAQ:QCOM) reported its Q4 2014 and fiscal 2014 earnings on November 5th. (Read Our Earnings Article) Though the company continued to see growth in the QCT segment (Qualcomm CDMA Technologies), driven by the rising penetration of 3G and 3G/4G multimode devices around the world, its QTL (Qualcomm Technology Licensing) segment faced challenges in China. In Q4 2014, Qualcomm’s QTL revenue declined 5% year to year  and was essential flat on a sequential basis.

China is a major source of growth for Qualcomm’s 3G/4G LTE chipset. Qualcomm’s licensing business is suffering on account of a dispute with Qualcomm licensees, under reporting by certain licensees, and sales of certain unlicensed devices in the region. The company expects to resolve the licensing issue in China soon, but remains uncertain of the timing. It is facing a governmental (NRDC) investigation for alleged monopolistic practices in China, in addition to ongoing regulatory investigations in the U.S. and Europe. The timing of the resolution of its challenges in China will be impacted by the timing of the conclusion of the NRDC investigation, in Qualcomm’s view. Resolving the licensing challenges in China remains one of its top strategic priorities for fiscal 2015.

Qualcomm believes that the QTL revenue growth many be muted to some extent in fiscal 2015. Given the difficulty in predicting the timing and impact of resolving the challenges in China, Qualcomm’s QTL guidance for fiscal 2015 incorporates a wide range of potential outcomes.  It expects QTL revenue in the range of $7.3 billion to $8.3 billion.  The lower end of the guidance assumes no material resolution of the licensing issues in China, whereas the high end of the range reflects more favorable outcomes with respect to several of the issues.

Below are the key issues that limit Qualcomm’s licensing growth potential in the near future and caste uncertainty around its future business in China.

See our complete analysis for Qualcomm stock here

1. Dispute With A Licensee: Qualcomm is undergoing dispute with one of its licensees, which resulted in the non-exclusion of a portion of that licensee shipment in the last two quarters. The company claims that it is still undergoing active discussions with the licensee and, like many past disputes, expects to resolve the situation in due course though the timing remains uncertain. Qualcomm mentioned in its Q4 2014 earnings call that it has made progress towards this end.

2. Under-Reporting By Chinese Licensees: According to Qualcomm, some of its Chinese licensees are under reporting sales and may continue to under report a portion of their 3G/4G device sales. Having robust and active compliance programs in place, the company is taking the relevant steps to address this issue. Until the issue is fixed, this will negatively impact Qualcomm’s licensing revenue. If the company’s efforts aren’t fruitful, it is prepared to enforce its rights under the licensing agreement.

3. Unlicensed Three Mode Activity In China: Qualcomm claims that the timing of the LTE launches in China, as well as device composition at China Mobile, has been a bit difficult to forecast. China Mobile is transitioning from its TD-SCDMA standard to TD-LTE. The company has signed more than 75 single-mode LTE licenses with Chinese OEMs, but OEMs supplying a meaningful percentage of three-mode devices remain unlicensed. Though the company is in discussions with many of these OEMs, the negotiations have been delayed on account of the pending NDRC investigation. However, Qualcomm did mention that the volume of three-mode devices that will ship during calendar 2014 has increased from its prior expectations. Despite these short-term challenges, Qualcomm expects to collect royalties over time on substantially all LTE device shipments, including three-mode devices sold in China.

4. Negotiating Licenses With New Potential Licensees: Qualcomm has witnessed an increase in sales of lower tier 3G connected tablets by a number of Chinese OEMs. It expects sales of these devices to grow in the future which is beneficial for 3G/4G attach rates and tablets. However, the tablet OEMs are mostly not the same companies that have been supplying the handsets in China, and therefore in most cases, are not currently licensed. Though Qualcomm is continuing to pursue licenses with this new base of potential licensees, the company claims that the discussions will take some time to complete, and the timing may be impacted to some extent by the pending NDRC investigation.

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