I think Qualcomm will best serve its shareholders by fighting tooth and nail to halt the fall of royalty rates that has been going on for the last nine years.
The fight between Apple and Qualcomm is a sure indicator that life in the smartphone market is getting tougher, which came to light in Qualcomm’s latest earnings release. FQ1 17A revenues / Adj-EPS were $6 billion / $1.19 compared to consensus estimates of $6.11 billion / $1.18. Guidance was very slightly weak with FQ2 17E revenues / Adj-EPS of $5.5 billion – $6.3 billion / $1.15 – $1.25 compared to consensus of $5.9 billionn / $1.19.
Apple’s dispute with Qualcomm is nothing new, and in fact from a brief examination of Apple’s complaint and Qualcomm’s response, it is clear that while times have changed, the arguments remain broadly the same.
Between 2006 and 2008, Qualcomm was embroiled in a bloody and bitter fight with Nokia which at the time was in the same position that Apple finds itself today. At that time, Nokia made almost all of the mobile phone industry’s profits and so it was the largest payer of royalties to Qualcomm. When its contract expired, it sought to lower the rate it was paying to Qualcomm and when negotiation did not work it resorted to the courts.
At the time, I believed that Qualcomm had the advantage and would eventually win, but Qualcomm decided to settle with Nokia in 2008.
Although the real details were not disclosed, I calculated at the time that this resulted in a new royalty rate of around 2.3% down from the old rate of 4.1% (of the wholesale price of the device). The problem with this is that everyone else was paying 4.1% and then went on to demand the same deal as Nokia.
More recently, Qualcomm has done a deal with China where the effective rate appears to be around 1%, which could very well spark a further decline in the overall global royalty rate that Qualcomm receives for its IP.
This is the heart of the problem with patents, as there is no real way to determine what should be paid to for them. I have long believed that patents are worth either (1) what an entity is prepared to pay for them, or (2) the present value of the cashflows that the patent generates.
This is why historical precedent is so important when it comes to patent licencing and here Qualcomm has a huge advantage. Qualcomm has hundreds of agreements and more than 20 years of history as evidence that its agreements have not damaged the mobile industry – in fact, quite the reverse.
The issue of course is that Apple simply wants a lower royalty rate, and even the terms of the deal in China appear not to be low enough.
Qualcomm claims Apple has rejected terms that are consistent with the deal it did in China and upon which it has struck most of its Chinese licenses.
The problem as I see it is that if Qualcomm gives Apple a discount, then the rate paid by everyone will go down yet again, and where it will end is impossible to tell. By fighting against Apple, it has a chance to arrest the general fall of royalty rates across the industry and stabilize them at what I estimate will end up at around 1%.
This is why Qualcomm must fight, as I think that the future of its IP licensing business depends on it winning the second time around. It will be painful and expensive but I can’t see how Qualcomm has much choice.
This article first appeared on RadioFreeMobile