Quick Thoughts: QCOM and AAPL Bury the Hatchet on the First Day of Trial

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April 16, 2019

Quick Thoughts: QCOM and AAPL Bury the Hatchet on the First Day of Trial

  • We expected QCOM/AAPL to settle, just not quite so quickly. The 6-yr. deal resolves all legal conflicts and sets a one-time payment for back royalties, future payments on device sales, and a chip supply agreement at undisclosed terms.
  • We believe QCOM would have fought to the bitter end to preserve its lucrative licensing model. The abrupt agreement suggests that AAPL was the one that blinked.
  • The deal almost certainly preserves QCOM’s “one rate on device sales for all IP” licensing structure, while carving out specific benefits for AAPL that won’t trigger most-favored clauses with other OEMs. Even with a discount, it is an unequivocal victory for QCOM, weakening future claims by others against it.
  • AAPL may be pessimistic that the recently completed FTC hearings on QCOM’s licensing practices and its own lawsuit against it would break in its favor. It may also be concerned that current modem partner INTC would not meet delivery and quality standards for the 5G modems needed for its 2020 iPhones.
  • Both companies will benefit from the certainty that the deal provides and from a significant reduction in legal costs.

We tried to get cute with QCOM. While we were confident that the great multi-front legal confrontation with AAPL would eventually be resolved favorably with an inevitable one paragraph press release citing a comprehensive licensing and chip supply agreement with undisclosed terms, we thought sheer stubbornness would keep the legal fight going until well into 2H19. Instead, that press release came this afternoon, revealing a 6-year deal with a 2-year option that will give QCOM a one-time payment for back royalties, establish royalty terms for future device sales, and set terms for chip sales. While we will never know the exact details of the agreement, QCOM’s future earnings reports will reveal the back-royalty payment (likely less than the $8.3B due under the prior arrangement), and the per iPhone royalty might be inferable in comparison with pre-deal QTL revenues. We suspect that AAPL will get a discount structured in a way that QCOM’s other licensees, all with most-favored-nations clauses, would not be able to claim the same benefit. Still, this is an unequivocal win for QCOM, and we wish that we had been patient enough to keep it in our model portfolio.

QCOM was prepared to fight to preserve its patent licensing program, conceived more than 25 years ago and intact after court challenges across the globe. The most recent AAPL led charge was just the latest, following legal actions by the Chinese Government, by Samsung in South Korean courts, by Nokia and Ericsson in the EU, by Broadcom and Motorola in the US, amongst many other battles. Qualcomm had prevailed in every one of these suits and investigations, which usually concluded with one of those terse press releases citing a comprehensive licensing and chip supply agreement at undisclosed terms. This latest tilt, which saw AAPL and QCOM jousting at the FTC, the ITC and in US federal court, did not seem likely to end differently and it didn’t.

Exh 1: Estimated quarterly unpaid AAPL royalties

We thought that AAPL, in the spirit of its pugnacious founder, would keep up the fight longer. Ultimately it settled before the FTC had issued a ruling and after just one day of its direct suit against QCOM. We suspect that the timing had a few reasons behind it. First, 5G is coming. AAPL will need to include the new wireless standard in its 2020 iPhone models and the window for choosing modem chip vendors may be close to closing. INTC, which has been the exclusive supplier of 4G modems for the iPhone X and XS lines, may not be ready with a competitive 5G chip. If AAPL was concerned, it would drive them to cut a deal like the one that it just signed with QCOM, which has already demonstrated viable 5G silicon. AAPL may also be pessimistic about the likelihood that it might prevail in its legal challenges, making the significant expense in pursuing them a considerable waste.

For QCOM, the deal sets even stronger precedent for the validity of its licensing model, and investors can have greater confidence in the sustainability of its royalty streams. It too will benefit from reduced legal expenses, a bigger boon for QCOM since they are a bigger piece of its overall costs. With this, QCOM management is also now free from the time commitment and distraction of the legal battle, able to focus attention on the more strategic decisions at hand. All of this is good for the company, and good for investors.

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