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Apple (AAPL) and Qualcomm (QCOM) decided a long time ago to settle their legal dispute. In doing so, Qualcomm's modem chips will become available again for use in Apple's iPhones, where they will be paired with the A-series application processors. Qualcomm will replace Intel (INTC), which previously took over from Qualcomm. as a provider of modem chips.
However, Qualcomm recently lost an antitrust case against it by the Federal Trade Commission ("FTC"). The court's findings have been numerous and some of them could have a direct impact on Apple, particularly with respect to the modem chips required for cellular connectivity. A PDF file containing all the court's findings and rulings is available at this link.
On paper, Apple could be the biggest beneficiary of the court's decision. But at the same time, investors should refrain from making decisions based on this change because the court's decision is still likely to appeal. A successful appeal could overturn the court's decision and nullify any positive benefit that Apple could have accumulated. Nevertheless, it is interesting to know what could be the potential impact on Apple whenever the final decision has been made.
Why having Apple as a customer is crucial for Qualcomm
The court has released a number of findings, but one of the most interesting is the importance for Qualcomm that Apple continues to buy its modem chips. This despite the fact that Apple chooses the MDM (Mobile Data Modem) product line containing only a thin modem. Such a product is less valuable than other chipsets, such as Qualcomm's Snapdragon SoC (SoC) system-on-chip, which contains both a modem chip and an application processor. The latter is usually chosen by other Qualcomm customers.
Nevertheless, Apple holds a dominant share in the field of high-end smartphones, which require a high-end modem chip that supports multiple modes. By designing Apple as a customer, Qualcomm can conquer the market and request other modem chip vendors the size and volume they need to recover the cost of developing their own modem chips.
If they can not sell enough modem chips, suppliers will have no choice but to leave the market eventually. This places Qualcomm in a much stronger position by eroding or even eliminating competition. Qualcomm could then use it to extract a number of concessions from the original equipment manufacturers ("OEM") needing modem chips for their handsets. If the equipment manufacturers do not respect them, they may not be able to sell their handsets because the phones will not work without a modem chip for connectivity.
The importance that Qualcomm attached to Apple was reflected in a presentation to the board of directors revealed by the court's findings. On a slide titled "OEM Strategy: Win the Designs That Matter the Most", Qualcomm said its primary focus was "Keeping its position as the leading supplier of Apple modems". Under the subtitle "Apple is important", Qualcomm described Apple as follows:
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The biggest consumer of high-end modems, rewarded with a binary price.
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Apple challenges suppliers to provide the best products.
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Apple's modems provider is able to fund R & D to maintain its leadership.
This information and other interesting information can be found on the PDF that was linked at the beginning of this article.
It was therefore very important that Apple stays with Qualcomm for its modems needs. Qualcomm did this by proposing a two-pronged approach. The first was to prevent other providers from offering their modem chips to Apple and the second was to encourage Apple to hesitate to turn away from Qualcomm.
How Qualcomm prevented other modems providers from dealing with Apple
Apple likes to have alternatives in its supply chain and Apple has sought, in addition to Qualcomm, suppliers capable of providing modem chips. Many companies were naturally interested in an agreement with Apple because of the volume of activities that they could generate. But before an agreement can be reached with Apple, suppliers should have a Standard Essential Patents ("SEP") license for cellular services. technology owned by Qualcomm.
However, even if Qualcomm is obliged, under "FRAND", to grant a license to whomever wishes, Qualcomm has begun to refuse to issue a license to its competitors. Without such a patent license, suppliers could not be certain that they would not face a Qualcomm patent infringement lawsuit. This is why the sale of modem chips to Apple is extremely risky, especially since many potential suppliers can not afford the potential financial consequences that could lead to bankruptcy.
Instead of the license he wanted, Qualcomm offered its potential competitors a contract called the CDMA ASIC Agreement. With this agreement, the vendors needed Qualcomm's permission to sell because they could only provide modem chips to "authorized buyers", as specified by Qualcomm. Qualcomm thus gained the ability to deny OEMs the ability to purchase modem chips from specific suppliers if it did not approve.
In addition, Qualcomm would use the royalties to essentially subsidize the price of modem chips whenever necessary. Since Qualcomm received patent payments, whether or not one of their chipsets was used, Qualcomm could hurt its competitors by lowering its prices to a level that was no longer worth it for its competitors. Basically, Qualcomm has ensured substantial benefits to the competition.
How Qualcomm prevented Apple from getting modem chips from third parties
Qualcomm did in fact grant a patent license to the original manufacturers who manufactured smartphones such as Apple, but only under certain conditions. For example, OEMs, including Apple, had to accept Qualcomm's "no license, no chip" policy, which meant that Apple could only obtain Qualcomm chipsets if they accepted prior to a patent license with Qualcomm.
Qualcomm also reserved the right to immediately halt the supply of chips if the license had expired and if negotiations to acquire a new one were still in progress. On paper, this meant that Apple was in a position where it had to accept the terms offered by Qualcomm, otherwise it would risk not being able to sell handsets.
In addition, Qualcomm offered discounts to manufacturers such as Apple, but only if they used Qualcomm chipsets on at least 85% of all handsets. So if Apple uses another provider, it should pay more for the modem chips because the discounts are no longer available. Qualcomm also reserved the right to require reimbursement of previously paid discounts, even if years had passed.
Basically, the structure of the agreements has been designed in such a way that it is difficult for Apple to free itself from Qualcomm because of the costs involved. The penalties imposed by switching suppliers made the task difficult, but not impossible. Apple has finally decided to use a second provider of modem chips in the form of Intel, despite all efforts of Qualcomm to prevent it. Qualcomm's efforts to hobble Intel began years before Intel actually enters the market and are continuing at almost every stage of the process.
Why is the Qualcomm antitrust case so relevant to Apple?
The judge in the case against Qualcomm ruled that his practices were in violation of the law and ordered the company to take a number of steps to ensure that the company was in compliance with the law. Several changes need to be made, but the most relevant ones for Apple include:
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More "no license, no chips" should give Apple more leeway to negotiate a more favorable deal for a patent license, because it no longer has to worry about ending up without chips modem.
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The court decides that Qualcomm must renegotiate the previous license agreements due to the lack of license and chip. This applies to all licenses already in place, implying that if Apple accepts Qualcomm's terms, fearing to be left without a 5G chip as many assume, it can renegotiate.
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Qualcomm must respect its commitment to the FRAND terms, which means that Qualcomm can not block current or future competitors by denying them a patent license. Apple would then be able to sign contracts with other suppliers than Qualcomm.
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Qualcomm can not enter into exclusive express or de facto agreements for the provision of modem chips. Other companies will be able to compete to meet the needs of Apple in terms of modems.
All of the above will have an impact on Qualcomm's customers, especially Apple. For Apple, the benefits are double, lower prices for modem chips and lower patent fees.
If competitors are able to obtain a patent license from Qualcomm, they can access the market without fear of violating Qualcomm's patents. These providers will have the opportunity to capture a portion of Apple's business due to the lack of exclusive contracts. More competing providers should result in a reduction in the cost of purchasing modem chips for Apple. It should also be easier for Apple to manufacture its own modem chips if or when it decides to move in that direction.
High patent fees have long been a concern for Apple
Qualcomm has a length ahead of all others in terms of patent license revenue, even though there are other companies with a similar patent portfolio. This indicates that Apple has a lot of leeway to reduce its patent payments to Qualcomm and bring them back to the same level as other MS holders. This is something that Apple has been trying to do in the past and it's one of the main reasons why Intel was originally chosen to become a second source of modem chips.
Apple's court testimony revealed that Apple was looking at patent royalty payments well below what they ultimately got. After negotiations, Apple finally accepted an incentive marketing agreement ("MIA"), which offered discounts reducing Apple's royalty payments per handset, provided Apple met a number of criteria.
However, patent royalties have always resulted in about five times more than what Apple initially wanted to pay, rising from about $ 1.50 to $ 7.50 after incentives. Subsequent agreements have increased Apple's royalty payments by one-third to about $ 10 for an iPhone. Apple also had to accept additional terms such as:
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Accept exclusivity.
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Do not initiate a FRAND dispute against Qualcomm.
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Do not encourage a third party to initiate a dispute with FRAND against Qualcomm.
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Not arguing that any sale of Qualcomm modem chips has exhausted Qualcomm's patents.
Note that the actual royalties to be paid by Apple depend on a number of factors, including the number of handsets sold during a given period, which may increase or decrease the final amount payable.
But the court's decision should give Apple the opportunity to reduce the cost of a Qualcomm patent license. He will be able to press harder and wait much longer to get a better deal. For example, Qualcomm will currently only offer a patent license as part of a portfolio, a bundle comprising both PES and non-PES. The former are subject to the FRAND conditions, but the latter are not. To the extent that such a package includes elements that it does not need, Apple pays substantially more than it should.
Apple faces its own headwinds
The court's decision made Apple probably the biggest winner. The court has subscribed pretty much to the arguments put forward by Apple for several years. In a way, Apple can argue that the findings and rulings of the court justified it. Assuming that a call does not succeed, Apple has everything to gain.
Apple could significantly benefit in the long run from a reduction in patent fees and lower prices for modem chips, but in the short term, Apple could be facing its own legal control of the regulatory authorities. But it is very unlikely that Apple is as severely exposed as Qualcomm. None of this could fundamentally change society and its economic model, as it does with the latter. However, it is always something that could weigh on the stock.
In addition, the trade war with China also creates uncertainty as the situation evolves. It is possible that the Chinese government is interfering with Apple's ability to do business in the country to retaliate against the US government. The more the situation deteriorates on the commercial front, the more likely it is that Apple will directly involve it.
Any escalation of the trade war with China is not good news for Apple. Such escalation could occur as early as the end of June at the G20 meeting. President Trump said he would decide whether or not to impose new tariffs on China based on what will happen at the G20 meeting. It is very likely that China will impose its own countermeasures at about the same time, which may involve Apple.
Even if the Chinese government does nothing, Apple could feel the effects if the people decided to boycott American products such as Apple iPhones. In contrast, the settlement of the trade dispute with China would eliminate downward pressure on the stock. All of these factors have the ability to move the stock up or down. So, until these problems are clarified, the most likely solution is that Apple stands aside.
Source: Wikimedia Commons
Disclosure: I / we have / we have no position in the actions mentioned, and we do not intend to initiate a position within the next 72 hours. I have written this article myself and it expresses my own opinions. I do not receive compensation for this (other than Seeking Alpha). I do not have any business relationship with a company whose shares are mentioned in this article.
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