For quite some time now, pessimism has been looming large over Qualcomm Inc.’s QCOM licensing business in China.
However, after an extensive tussle with regulators and domestic smartphone companies, things are starting to look up for Qualcomm in China, thanks to its recent 3G/4G patent-licensing deal with Chinese smartphone maker – Xiaomi Inc.
The announcement of the deal has aroused fresh interest in the stock. Notably, the company’s shares gained more than 5% in yesterday’s trading session, rising the maximum in over four years, dispelling investors’ fears over Chinese vendors overlooking Qualcomm’s patent licensing.
Deal Details
Per the agreement, Qualcomm has accorded Xiaomi a royalty-based license to develop, manufacture and sell devices that use Qualcomm's 3G and 4G technology. The financial details of the deal have been, however, kept under wraps.
Notably, the royalties that Xiaomi will be paying for those patents are consistent with the rectification plan submitted by Qualcomm to China's National Reform and Development Commission (NRDC).
Issues in China
Way back in Nov 2013, the NDRC had initiated a probe into Qualcomm’s monopolistic practices in China. Following that, numerous Chinese smartphone manufacturers started retaining royalty payments to Qualcomm encouraged by the inquiry into the company’s business practices. Notably, the NDRC determined that the company is exercising monopolistic power in the country.
In Feb 2015, Qualcomm paid a fine of $975 million and also agreed to lower licensing fees in order to settle the 14-month old investigation in China. In addition to paying the fine, the company offered new licensing norms which can be classified into four broad categories, which are:
First, Qualcomm will offer licenses to its current 3G and 4G essential Chinese patents separately from licenses to its other patents and will provide patent lists during the negotiation process.
Second, 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.
Third, 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.
Importance of the Deal
For Qualcomm, associating with China’s leading smartphone manufacturer means additional royalties. Moreover, the deal puts speculations surrounding the chip maker’s regulatory woes in China to rest.
Notably, Xiaomi has seen a spectacular rise in the smartphone space. As per International Data Corporation’s (IDC) figures, it is the fourth largest smartphone maker that accounted for about 5% of all smartphones sold globally in the past four quarters.
Meanwhile, this recent deal will likely boost Qualcomm’s top line, particularly if other Chinese smartphone manufactures follow in the footsteps and start paying royalties to the company again. Notably, Qualcomm has now inked agreements with four of the top five phone makers in China.
Regulatory Issues Linger
However, regulatory proceedings against Qualcomm are still on the rise with the handset chip maker facing antitrust cases in various countries.
Last month, Qualcomm revealed that South Korea’s Fair Trade Commission has alleged that some of its patent-licensing practices are illegal and anti-competitive.
In Jul 2015, the European Union (EU) Competition Commission announced the initiation of two probes to determine whether the company has been abusing its dominant position in the market.
Additionally, the company is facing or has faced regulatory investigations in China, Japan and Europe as well as in the U.S. In all the cases, the regulators’ main concern is Qualcomm’s licensing model and misuse of its powerful intellectual property rights (patents) to maintain market dominance.
Our Take
Qualcomm is the largest baseband chipset developer for mobile handsets globally. The company’s chipsets are used in Apple Inc.’s AAPL iPhone, Alphabet Inc. GOOGL-developed Android smartphones and Microsoft Corp.’s MSFT Windows handsets.
We believe signing of this new patent license agreement with Xiaomi symbolizes progress in lessening the chip maker’s struggles in the country. The deal thus takes it a step closer to solve issues pertaining to its most profitable business of licensing patents and aid it in securing some foothold in the Chinese market.
Further, this might lead the way to more licensing deals, resulting in significant revenue generation for the company and also lending more upside to the stock.
Meanwhile, settlement of several regulatory issues is a major concern for Qualcomm at this juncture because if found guilty, the penalty imposed may hurt the company’s profits considerably.
Qualcomm currently carries a Zacks Rank #5 (Strong Sell).
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