Apple, HTC Drop Charges

Apple Inc. ( AAPL - Analyst Report ) recently settled its long-standing patent dispute with the Taiwanese smartphone maker HTC with the two companies dropping all charges against each other. The companies also entered into a 10-year licensing agreement, the financial terms of which were not disclosed.

The patent dispute between Apple and HTC dates back to 2010. Apple’s co-founder late Steve Jobs had sued HTC, the user of Google’s ( GOOG - Analyst Report ) android operating system, for copying certain iPhone features. This initiated Apple’s fight against Google’s Android, which was gaining popularity.

We believe that Apple has settled its dispute with HTC as it is not worried about competitive threats from the latter. According to IDC, HTC’s market share shrunk to 4.0% in the third quarter of 2012 from 10.3% in the year-ago quarter. During the same period of time, Apple’s market share rose from 13.8% to 15.0%. Apple was also well ahead in terms of shipment growth, which increased 57.3% year on year compared to the 42.5% contraction suffered by HTC.

We believe that this settlement is a strategy for Apple to concentrate all its efforts to counter Samsung, the largest vendor of Android systems and the leader in the smartphone market. Thus, Samsung is a bigger threat than HTC. Samsung’s third quarter shipments have skyrocketed 100.4% due to its broad portfolio and competitive pricing. Moreover, Samsung also expanded its market share to 31.3% in the third quarter from 22.7% in the year-ago quarter.

Hence, we believe that Apple’s settlement with HTC is a strategic plan to restrict its focus on the larger peers. Apple is more interested to compete against the market leaders and reclaim its top position. The impending lawsuits and stiff competition from Samsung with its wide range of products in the smartphone and tablet markets will remain an overhang on the stock going forward. Thus, a reduction in the number of litigations will be a positive catalyst for the company going forward.

We believe that Apple remains the biggest growth story over the long term based on its superior product pipeline, Apps, iCloud and loyal customer base. Apple is also well positioned to gain from international expansion going forward. Moreover, the recent shareholder-friendly moves, such as dividend payment and share buyback, are expected to drive the stock going forward.

However, we believe that Samsung will continue to grab market share, particularly in developing countries such as China, based on its diversified product portfolio that caters to every income group. Apple’s ability to spur the popularity of its products in developing nations, where pricing is often an important consideration, will go a long way in deciding the company’s future growth.

Moreover, increasing product related costs and supply chain constraints may hurt profitability going forward.

We maintain our Neutral recommendation over the long term (6-12 months). Currently, Apple has a Zacks #3 Rank, which implies a Hold rating in the near term.