What Do The Latest Charges In South Korea Mean For Qualcomm?

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Leading wireless technology developer Qualcomm (Nasdaq:QCOM) is facing anti-trust charges by the FTC (Fair Trade Commission) of South Korea, which regarded its licensing practices as anti-competitive and violating the Korean law. [1] The company has been accused for unfairly charging licensing fees as a percentage of device sales price rather than the price of the chipset in the device. These allegations can weigh heavily on Qualcomm’s licensing business, which constitutes over 50% of the company’s valuation, according to our estimates. As a result of these anti-trust charges, Qualcomm may have to pay heavy fines and lower its royalty rate in the region. Earlier this year, the company paid litigation charges of $975 million to settle a similar regulatory investigation in China and had to lower the royalties it charges to licensees in the market.

Investors were already worried about Qualcomm’s situation in China, where the company is not able to conclude new licensing deals with a number of  Chinese OEMs. With the latest charges in South Korea, their concerns have been aggravated, which has sent Qualcomm’s stock down by close to 10%. In the section below, we examine how these charges can affect the company’s business model going ahead.

Our price estimate of $65 for Qualcomm is approximately 32% above the current market price. We are in the process of updating our model in light of the recent events.

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See our complete analysis for Qualcomm stock here

The South Korean Charges Can Cause Serious Damage To The Company’s Business Model

If Qualcomm loses its case in the latest allegations by the South Korean regulation, the company might have to charge royalty rates as a percentage of chipset price rather than the overall device sales price. This can be a serious blow to Qualcomm’s licensing business as the average selling price of a Qualcomm MSM chipset is approximately $18, which is much lower compared to the average selling price of a 3G/4G device, which is approximately $200. [2] This can translate to a significant decline in profits from the South Korean region, which constitutes around 23% of Qualcomm’s global revenue. Also, the company faces the risk of being probed for similar charges in other countries as well, which poses a serious threat for its global royalty rates.

However, if the FTC agrees to settle the dispute by lowering royalty rates as a percentage of device sales prices, similar to China, the loss will be comparatively lower. Moreover, the current dispute can take years to settle and before that the company can enjoy the same royalty rates in the region. But as evident in Qualcomm’s Chinese settlement, the company’s licensing revenues can be impacted even after the dispute is settled, as it may take time for the company to conclude new license agreement with South Korean OEMs.

Qualcomm Can Hedge Its Risks By Expanding Its Patents Portfolio In Other Areas

Qualcomm’s licensing and chipset revenues from smartphones have been jeopardized by litigation charges and the tough competition from other players. However, we remain confident about the company’s long-term outlook, both in smartphones and adjacent areas where its mobile technologies and capabilities can bring next generation solutions. These areas include automotive communications, the Internet-of-Things (IoT), mobile computing, networking, small cell commenucations and data center solutions.

These segments have an addressable opportunity of more than $10 billion; and based on a mix of third-party estimates and Qualcomm’s own forecasts, opportunity for these four areas is expected to double to more than $20 billion by 2020. [3] However, the company needs to expand its R&D and patent portfolio in these areas at a faster rate to offset the decline in its licensing revenues due to litigation charges globally.

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Notes:
  1. Qualcomm Says South Korea Recommends Fine for Alleged Antitrust Violations, Wall Street Journal, Nov 18 []
  2. Average chipset price calculated based on the number of MSM chipsets and QCT revenues in the company filings in FY 2015 []
  3. Qualcomm Q3’15 Earnings Transcript, Seeking Alpha, July 22, 2015 []