Qualcomm’s Licensing Business Could Be Undermined By The Rising Number of Lawsuits Against The Company

Last week, the U.S. Fair Trade Commission (FTC) filed suit in Federal Court against Qualcomm (NYSE:QCOM) alleging that certain monopolistic business practices of the company were in violation of Fair Trade Commission Act of 1914, in which basic US patent law was first set down. To compound to Qualcomm’s problems was a $1 billion lawsuit by the smartphone giant, Apple (NYSE:AAPL), days after the complaint by the U.S. FTC. Apple alleges that Qualcomm overcharged it for chips and refused to pay rebates worth $1 billion because the smartphone maker was engaged in discussions with Korea Fair Trade Commission (KFTC) in another legal proceeding against Qualcomm. Apple also alleged that Qualcomm attempted to persuade it to provide false information to the KFTC in order to get the rebates. ^[1]. Qualcomm derives more than 10% of its revenues from Apple. As investors took note of the seriousness and the rising number of these lawsuits, Qualcomm’s stock price tumbled by approximately 13% on Monday.

It should be noted that only recently Qualcomm was notified by the Korean Fair Trade Commission (KFTC) that it intends to file a written judgment against the company regarding its licensing terms that includes a fine of $854 million.  The KFTC alleged Qualcomm for the abuse of its market dominance. Furthermore, the KFTC issued a broad set of guidelines that Qualcomm will have to follow while executing licensing contracts in South Korea subsequent to the formal filing.  We highlight that the provisions will govern Qualcomm’s business with major handset manufacturers LG and Samsung, the latter of which is also a major Qualcomm licensee and at times the foundry supplier of a major portion of its processors. Its silence in the proceedings is no doubt related to this complex relationship.

We have a price estimate of $66 for Qualcomm’s stock, which is above the current market price.

See our complete analysis for Qualcomm

Lawsuits Can Alter Qualcomm’s Licensing Business Model

Though Qualcomm strongly disputes these charges, there can be significant consequences for the company if its appeal gets rejected. Key to both the FTC and KFTC charges is a basic tenet of US Patent law:  That holders of widely used “Standard Essential Patents” (SEPs) are required to license them to competitors on a “Fair, Reasonable and Non-Competitive” basis (so-called FRAND commitments.) Both charge as well that Qualcomm has refused to license its patents to its comepetitors (Intel and Mediatek).  One obvious consequence would be increasing competition for Qualcomm in the chipset market. Consider the KFTC ruling, which stated in its procedural guideline for Qualcomm that it will have to follow the terms with all “enterprises that supply modem chipsets to a handset company” manufacturing/selling handsets in South Korea. Clearly, this implies that other major chipset companies such as Intel and MediaTek will now stand a chance to compete with Qualcomm in the chipset market. This comes from the fact that Intel and MediaTek might consider supplying modem chipsets to South Korean smartphone makers. Furthermore, given its remarkable features, Qualcomm’s royalty rate is likely to be pressured or even reversed. For instance, the terms Qualcomm is said to have imposed on Apple include  a 5% royalty rate imposed on the full cost of the iPhone. This will likely be seen to be unreasonable.  More typically, a rate of only 3% would be levied on the chipset selling price.

All these factors can weigh heavy on Qualcomm’s overall profitability as licensing business constitutes more than 80% of the company’s operating income. Further, these lawsuits can dent Qualcomm’s cash position because the company might end up paying significant fines to settle the dispute. In 2015, Qualcomm paid a fine of $975 million in order to settle a regulatory investigation in China.

1. Apple Says Qualcomm Overcharged For Chips and It’s Suing for $1 Billion, Fortune, January 23, 2017 [↩]