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Qualcomm's Party Is Over As Apple Attacks & Regulators Scrutinize

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As more information on Qualcomm’s (QCOM - Free Report) licensing policies come to light, it’s clear that the company is skating on some pretty thin ice. But given the fact that it is one of the major providers of wireless technology with operations across a number of countries, it’s hard to tell how each of these countries will deal with the situation.

There Are Many Factors At Play Here

For one, Qualcomm has the policy of bundling its standard essential patents (SEP) with other proprietary patents and withholding from licensees information about just what they are licensing. So if it licenses patents A, B, C, D, E and F to say Apple (AAPL - Free Report) , which decides it can work around A and create its own solution for B, licensing only what it must, i.e. C, D, E and F, Qualcomm doesn’t give it that option. And because it doesn’t know when it is licensing a standard essential patent (that must be licensed on fair and reasonable terms) or other patent, it is prevented from challenging Qualcomm’s rates.

Second, Qualcomm charges royalties on the finished product rather than on the component using its technology, which means that high-priced end products like an iPhone generate more income than lower-priced products like an HTC Desire. So Apple seems justified in its claims that Qualcomm is charging a premium on Apple innovations.

Third, Qualcomm charges a 5% royalty on the value of phones that incorporate its own chips and the value of those that incorporate chips from companies licensing its technologies. This means that if a handset maker buys a Qualcomm chip, it still has to pay a 5% royalty because of other unspecified patents that Qualcomm licenses as part of its bundle. Apple says that when it buys a Qualcomm chipset, it doesn’t owe Qualcomm anything at all, but we don’t know yet.

Fourth, Qualcomm has a monopoly in mobile chipsets, or basebands that enable phones, tablets, watches, etc to connect to cellular networks. So if a handset maker doesn’t license its technology, it refuses to sell them a chipset. The FTC says that handset makers have not tried litigation because of their fear that Qualcomm would cut chipset supply. Qualcomm also doesn’t license its technology to prospective competitors like Intel (INTC - Free Report) and Samsung that could have then made their own supporting chipsets. Here again, because the SEP patents that it is bound to license have been camouflaged under a bundle that contains other patents, taking legal action is complicated. At any rate, Qualcomm contends that its policies haven’t prevented companies like MediaTek, Samsung and Intel from building successful chipset businesses.

Bottom Line

Despite Apple suppliers and another unnamed licensee (possibly Samsung) stopping payments, Qualcomm’s licensing business grew 48% sequentially in the just-reported third quarter, testimony to the strength of its business model. The lower-margin chip business also did well, growing 12%. If its acquisition of NXP Semiconductors goes off without hiccups (Qualcomm expects to close the deal at the agreed-upon price by year end), it will again be very strongly positioned in emerging technologies.

The only fear is that if other smaller players may join the fight, or answer FTC enquiries in a way detrimental to Qualcomm, it may be in for fines or directives. A fine or settlement is actually good as China and Korea agreed to, but it won’t be enough for Apple, which is looking to inject competition into the space. This battle is far from over.

Qualcomm has a Zacks Rank #4 (Sell) but you can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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