Yesterday, Qualcomm Inc. (QCOM), the largest mobile chipset developer globally, reached an agreement with Chinese regulatory authority, National Development and Reform Commission (NDRC), settling the 15 month old antimonopoly charges against the company.
As a settlement, Qualcomm will pay a fine of $975 million together with several royalty concessions to Chinese handset developers. Meanwhile, the company’s management also raised its financial outlook for fiscal 2015.
The stock price Qualcomm, which has lost value of around 18% over the last ten months, was up nearly 4% yesterday, including normal market trading time and aftermarket trade.
The Penalty
Way back in Nov 2013, the NDRC had initiated a probe into Qualcomm’s monopolistic practices in China. Following that, the NDRC determined that the company is exercising monopolistic power in the country. In addition to paying a fine of $975 million, the company is also offering new licensing norms which can be classified into 4 broad categories, which are:
Firstly, Qualcomm will offer licenses to its current 3G and 4G essential Chinese patents separately from licenses to its other patents and it will provide patent lists during the negotiation process.
Secondly, the chipmaker has agreed to lower its licensing fees to 5% for 3G devices and 3.5% for 4G devices including tri-mode LTE-TDD devices that do not have CDMA or WCDMA for branded devices sold for use in China, using a royalty base of 65% of the net selling price of the device.
Thirdly, Qualcomm will give its existing licensees an opportunity to elect to take the new terms for sales of branded devices for use in China as of Jan 1, 2015.
Finally, Qualcomm will not condition the sale of baseband chips on the chip customer signing a license agreement with terms that the NDRC found to be unreasonable or on the chip customer not challenging unreasonable terms in its license agreement.
What Drove the Stock Price?
The Chinese wireless market is currently the major growth area for Qualcomm. All three Chinese wireless behemoths have ramped up the deployment of 4G LTE (either TDD or FDD format) in recent times. Qualcomm generates 74% of its revenues from chipset sale but earns 58% of its profit before tax from high-margin licensing business which generates massive royalties.
In fiscal 2014, the company generated nearly 50% of its global revenues ($26.5 billion) in China, with a large chunk of profit coming from higher-margin royalties earned from the company's licensing business. Therefore, a setback in China is likely to jeopardize its overall business model.
Nevertheless, the penalties that the company has to bear (including fine and royalty rate adjustment) are actually lesser than what the market was estimating. Many analysts opined that Qualcomm may have to pay over $1 billion coupled with forgoing a significant rate of LTE-TDD royalty.
Meanwhile, management stated that it will no longer challenge the NDRC’s decision and will cooperate with the Chinese government. This indicates that uncertainties about Qualcomm’s Chinese operations have come to an end.
Outlook Raised
Qualcomm has raised its total revenue and non-GAAP EPS guidance for fiscal 2015 on the heels of the NDRC settlement news. The current guidance for total revenues stands within the range of $26.3-$28 billion compared with the prior guidance of $26-$28 billion. The new non-GAAP EPS is projected within the range of $4.85-$5.05 against the prior guidance of $4.75-$5.05.
The Bottom Line
Qualcomm is the undisputed market leader for CDMA-based mobile microprocessors using baseband technology. The company’s chipsets are primarily used in high-end smartphones developed by Apple Inc. (AAPL), several handsets using Google Inc. (GOOGL) developed Android operating software and Microsoft Corp. (MSFT) developed Windows phones.
Recently, Samsung, the largest customer of Qualcomm decided not to use Qualcomm’s flagship Snapdragon 810 chipset in its upcoming Galaxy S6 smartphone. In addition, the U.S. Federal Trade Commission is investigating the company’s licensing business regarding fair and reasonable commitments, while the European Commission is examining rebates or financial incentives provided by the company related to its baseband chipsets.
At this juncture, settlement of issues in China, which currently offer significant growth opportunities, is a major achievement for Qualcomm.
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