Apple’s Patent Infringement Headache Could Lop 15% Off Upside Estimates


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Motorola (NYSE:MOT) filed a complaint with the U.S. International Trade Commission (ITC) a few months ago accusing Apple (NASDAQ:AAPL) of infringing certain patents used in the iPhone, iPod Touch and certain Macs. This is not the first time a patent infringement complaint has been launched against Apple. Nokia (NYSE:NOK) and Kodak have also sued Apple in the past.

Apple responded with a countersuit against Motorola claiming violations of 24 patents. [1] We believe that the upside to its stock is limited if Apple indeed wins this case while the downside could include a one-time large penalty and potentially more royalties for future devices. In this scenario, it would raise Apple’s production costs and reduce its gross margins, which in turn would weigh on our price estimate of $418. We forecast the combined result could knock 15% off of our price estimate.

Potential Downside to Apple Stock

We estimate that iPhone gross margins were around 61% in 2009. We derived this based on iSuppli estimates that iPhone input costs were around $179, and with the inclusion of $50 royalty fees, the total input cost per iPhone amounts to $229 for 2009. Apple’s per unit selling price for the iPhone was around $609 in 2009, resulting in gross margins of around 61% per device.

[trefis_forecast ticker=”AAPL” driver=”10090″]

As competition from the lower priced Android, RIM’s Blackberry and Motorola smartphones picks up, we believe that Apple will have to cut iPhone prices resulting in a decline of Gross Margins to 38% by the end of the Trefis forecast period.

Apple pays around $50 in royalties for every iPhone sold as part of its direct expenses. We believe that Apple pays ARM holdings, which holds the patent technology for the processors that goes into Apple (A4). [2]

However, in a worst case scenario where some or all of the patent infringement complaints go against Apple, we believe the company could be forced to pay higher royalties. If Apple paid an additional $50 royalty for every iPhone sold, its gross margins would decline to around 26% by the end of Trefis forecast period.

This scenario could create a downside of around 15% to the $418 Trefis price estimate for Apple’s stock.

Apple Barraged by Patent Infringement Complaints

Motorola claims that it attempted to license technology to Apple for which Apple refused to pay. It has sued Apple for 18 patents, which include patents related to wireless communication technologies, such as WCDMA (3G), GPRS, 802.11, antenna design, and key smartphone technologies including wireless email, proximity sensing, software application management, location-based services and multi-device synchronization.

Similarly, Nokia sued Apple for seven patents infringements in December 2009, while Kodak sued Apple for several patents infringements in Jan 2010.

Patent infringement cases are generally complex in nature which results in a lot of uncertainty around them. These disputes generally take many years to resolve, and hence we believe that there is no immediate threat to Apple.

Limited Upside to Apple if it Wins Cases

Apple recently countersued Motorola for violating 24 patents. Even if Apple wins this case, it stands to gain very little from this win. Motorola’s market share is less than 3% in 2010 by our estimates, [3] and we expect it to decline to 1.6% by the end of Trefis forecast period.

[trefis_forecast ticker=”MOT” driver=”5226″]

Also Motorola’s phones average pricing for 2010 is expected to be around $214, which is much lower compared to iPhone’s expected pricing of $606 for 2010 [4]. This implies that the royalties that Apple would gain by winning this case or increased sales from handsets would be limited.

While we do not expect any immediate term impacts, these legal disputes could point to future issues the company might face, which is an added cost of being a market leader in smartphones and tablet markets.

You can see the complete $418 Trefis Price estimate for Apple’s stock here.

Notes:
  1. According to an AppleInsider report []
  2. ARM’s technology behind Apple A4 []
  3. Data estimated from quarterly filings of the first three quarters of 2010 []
  4. ref:4 []
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