What’s At Stake For Qualcomm As Apple Expands Its Lawsuit?

by Trefis Team
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Last week, Apple stepped up its legal battle against Qualcomm (NYSE:QCOM), targeting the company’s licensing practices that require its chip customers to also pay licensing fees for its patents, while seeking restitution of all excessive royalties that it claims to have paid to date. The move comes less than six months after Apple sued Qualcomm alleging that it withheld $1 billion in royalty rebates. The escalation increases the uncertainty surrounding Qualcomm’s lucrative technology licensing unit, which is already entangled in legal battles with South Korean regulators (who levied an $854 million fine on the company late last year) and the U.S. Federal Trade Commission, which alleges anti-competitive practices relating to the company’s industry-standard wireless patents. In this note, we take a look at some of the potential repercussions of Apple’s move on Qualcomm.

See our complete analysis for Qualcomm

Apple’s Allegations

Apple is directly targeting Qualcomm’s licensing business, alleging that it is illegal, and is designed to extract high royalties for every wireless device shipped. For instance, Qualcomm typically requires mobile vendors who want to purchase its mobile chip sets to also license its wireless patents. Apple says that Qualcomm is wrongly basing its royalty charges on the device’s overall value, causing Apple to pay several times what budget manufacturers pay. Apple’s devices have generally been getting more expensive on account of new proprietary technologies and higher memory content, but the company says that it is being forced to pay Qualcomm higher royalties whether or not the advancements of the device come from Qualcomm technology. For instance, if a customer buys an iPhone 7 with 256 GB of  storage ($849) instead of one with 32 GB ($649) of memory, Apple pays a higher fee with Qualcomm, despite the fact that the communications technology on both devices is the same.

There’s A Lot At Stake For Qualcomm

The stake in the legal battle with Apple are likely to be very high for Qualcomm. Apple is one of Qualcomm’s biggest customers, with the royalties that it pays estimated to account for as much as 30% of Qualcomm’s earnings. Apple has already been withholding payments to its contract manufacturers for the royalties that they owe Qualcomm, and it has indicated that it will not start paying them again until the legal issues are sorted out. This forced Qualcomm to slash its revenue guidance for the quarter ended June by $500 million to between $4.8 billion and $5.6 billion. Apple also appears to be reducing its dependence on Qualcomm modems, with its iPhone 7, which was launched in 2016, sporting Intel modems on some variants.

A court win by Apple could undermine Qualcomm’s basic business model, potentially setting a precedent for similar litigation from other vendors. This is something Qualcomm would prefer to avoid, given that it has been growing more dependent on its licensing business (QTL accounted for a massive 78% of its profits before taxes in FY’16, compared to around 63% two years ago). On the other hand, for Apple, a company with over $80 billion in gross profits (FY’16), the stakes are much lower, as the matter is likely to pertain to under 3% of its total dollar profits. While Apple is likely to remain dependent on Qualcomm technology for its devices (Qualcomm practically has a monopoly over the CDMA technology used by carriers such as Verizon), Qualcomm has a lot more to lose in this legal battle. This gives us reason to believe that the two companies will not engage in a protracted legal battle, instead opting for an eventual settlement.

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