Even as an appeal (AAPL) lawsuit against Qualcomm (QCOM) was initiated, the two parties announced a far-reaching agreement. The settlement interrupts all legal disputes between the companies and establishes a new license agreement between them. Apple will also make an unspecified payment to Qualcomm.
According to Qualcomm, the agreement applies for an additional $ 2 per EPS (accepted per year) as soon as Qualcomm begins shipping modems to Apple:
First let me point out that I'm not the only one who thinks that way. As Roger Kay noted in WSJ yesterday,
"This is a tremendous gain for Qualcomm because the lawsuit and associated suits were life threatening to the company," said Roger Kay, an analyst at Endpoint Technologies Associates. "For Apple, a loss would have been financially punished, but for Qualcomm this would have ruined the business. This is like a new life. "
I also never signed Apple's presentation of Qualcomm as a nasty monopolist who illegally" taxed "the iPhone. As I noted in June 2017, Apple's displeasure over the "tax" paid by the contract manufacturers (CMS) seemed to be due to ignorance of the specific licensing terms:
Apple claims that Qualcomm's patents related to modems Only Qualcomm can give the right to charge the royalties according to the value of the chips themselves.
However, this is not the agreement that Qualcomm has negotiated with the CMs. It can be argued that the CM did not have to agree to the broad portfolio license that exhausting patents would protect them from Qualcomm's legal action. However, the fact remains that they usually have their licensing agreements completed long before they start working for Apple. Thereafter, the contracts are legally enforceable, as Qualcomm claims.
This view, of course, was never popular in the Apple Fan media, which enjoyed Apple's legal crusade against the monopoly. Apple's rationale for the crusade was formulated by Apple representative Ruffin Cordell in his opening remarks for the case succinctly. Once again, according to the WSJ:
He compared Qualcomm's licensing practices with someone who appeared at a KFC restaurant to order chicken, but was told to get a "food license" from the fast food chain first, because the Chicken Colonel contains Sanders secret recipe. Imagine the license costs $ 17 and the bucket of chicken $ 17.
While the analogy summarizes Apple's position, this is a poor and inaccurate analogy for the actual situation. Qualcomm's agreement with the CMs related to a broad patent portfolio that included not only baseband modems but not just standard essential patent (SEPs). Apple has rightly claimed that Qualcomm is required to license SEPs on fair, reasonable and non-discriminatory terms (FRAND).
The non-SEP portion of the portfolio was the primary weapon that Qualcomm used against Apple's subsequent patent infringement lawsuits against Apple around the world. Qualcomm was able to lawfully calculate the desired price for these patents. The abrogation of CM's license agreements by Apple immediately violated these patents.
Apple had stepped into a trap, or more precisely, a legal minefield, but this was little or not known in the media, apparently at Apple , Last Friday, Apple Insider told readers "what they expect from the trial":
However, Cook reiterated the same letter Apple had said during the talks with Qualcomm – specifically, that there was nothing wrong with that.
"You see, the truth is, we have not had discussions with them since the third calendar quarter of last year," he said. "That's the truth, I'm not sure where this thinking comes from."
A few days later, Qualcomm disagreed with Cook's remarks and called them "misleading."
No matter if there were discussions or not. Apple lawyer William Isaacson made it clear that Apple and Qualcomm had no agreement before the trial.
To explain the sudden turnaround, the media has generally highlighted Qualcomm's leadership in 5G modems and Intel's apparent failure to deliver a 5G modem that could be integrated into 2020 iPhones. Intel (INTC) had hyped its "leadership in 5G" for a long time.
I certainly never bought the concept of Intel's 5G guide, and I doubt Apple did. Apple clearly tried to develop Intel as a vendor, and knew that there was a risk that Intel might not be able to deliver on time.
This was undoubtedly an important consideration, but I doubt that this in itself would play a role enough to make Apple turn its back on its crusade. Let's recall that Apple's latest crusade against monopoly, the ebook antitrust case, was based on the alleged evils of Amazon's (NASDAQ: AMZN) "monopoly" of e-books.
Apple went all the way to the Supreme Court and lost the case. Throughout the case, Apple CEO Tim Cook said that "Apple did nothing wrong", confirming that he did not understand the distinction between law and justice.
During the appeal process, an appeal judge, Debra Livingston, has flatly condemned Apple for "market vigilance that is completely alien to antitrust laws." Apple's crusade against Qualcomm and, in particular, the CM's request to violate its licensing agreements is, in my view, an even more timid form of vigilance.
I believe that in the end, Apple's legal team and Apple management had some insight into how flawed the Kentucky-rooted thesis really was. However, this is not to excuse the behavior of Qualcomm.
Numerous competitors' regulators have found Qualcomm's tactics abusive and attempting to restrict them, particularly with regard to the threat of withholding chips instead of licensing agreements. However, no attempt was made to ban Qualcomm from pooling patents into a broad portfolio license. There is nothing illegal about the practice itself. It's done all the time. Similarly, it is not forbidden to evaluate license fees at the handset level, based on an extensive portfolio that covers many aspects of smartphone operation.
Kerrisdale Short-Term Re-Examined
Kerrisdale Capital Management published a brief thesis in Seeking Alpha a few days before the FTC put forward final arguments in its antitrust case against Qualcomm on January 29. It seems appropriate to review Kerrisdale's arguments in the light of recent events.
Kerrisdale reiterated the FTC complaint largely on the assumption that this was the case the FTC will prevail. Judge Lucy Koh stated that it would take a considerable amount of time to decide the case, suggesting that the matter will not be cut and dried. I even believe that the legal issues have always been more complex than what the FTC or Apple have accepted.
The key points in the FTC appeal:
Qualcomm has a "no license, no chips" policy, which requires handset OEMs to license Qualcomm's standards and key unfair terms.
Qualcomm refuses to license its standards-compliant patents (SEPs) to fashion chip manufacturers, in violation of its reasonable and non-discriminatory (FRAND) obligations towards standardization organizations (SSOs).
Qualcomm concluded "exclusive agreement with Apple".
Qualcomm's licensing agreements require OEMs to pay royalties, even if the OEM uses non-Qualcomm chips. This represents an inappropriate "tax" on mobile phones that prevents OEMs from using non-Qualcomm chips. This tax violates the principle of "patent fatigue" according to which the patent holder for an integrated circuit could not collect patent fees from later users of the chip, such as OEMs.
Qualcomm's dominance of mobile modem technology and licensing practices has hurt competition.
Much of the FTC complaint appears to be grounded in Apple's claims and therefore suffers from Apple's misconceptions about the licensing agreements that Qualcomm has made with Apple's contract manufacturers. Both Apple and the FTC characterize the agreements with the manufacturers as royalties for SEPs, which are valued based on the value of the entire handset. Apple and the FTC argue that this is unfair and that Qualcomm is only entitled to charge royalties based on the value of the chipsets.
Apple and the FTC would be right if Qualcomm had done that. However, the licensing agreements concluded with the contract manufacturers covered a broad patent package that included SEPs and non-SEPs. Qualcomm rightly argues that patent pooling is a long-standing practice.
In May 2017, I pointed out that Apple's settlement of the patent infringement lawsuit in Nokia's patent application included the licensing of a patent bundle. The FTC and Apple seemed to ignore the fact that patent pooling is absolutely legal.
The bundle license is also used to explain the application for handsets, even if they do not use Qualcomm chips. The terms of the license agreements were clear for all phones manufactured by the contract manufacturers.
The Kerrisdale letter noted that Judge Koh had already decided that Qualcomm was required to license SEPs to competing chipmakers under FRAND conditions. I was actually surprised that Qualcomm even fought against it, as the result was never really questioned.
Kerrisdale felt that the verdict showed that Koh sided with Qualcomm and that the ruling completely undermined his licensing practices. However, I am not convinced that this will be the case. This depends somewhat on the value of non-SEPs.
Kerrisdale made its assessment on the basis of the few non-SEPs that surfaced in the context of Qualcomm's patent infringement lawsuit against Apple and the contract manufacturers. Kerrisdale argued that Qualcomm must have gone through its patent portfolio to find the best patents, some of which were found invalid or at least not valuable. Kerrisdale argued that if that's the best Qualcomm could have, the rest of the non-SEPs can not be of much value.
This is not an inappropriate assessment, but I do not want to rate it Qualcomm's portfolio is based on these few patents. Qualcomm, in turn, has argued that its licensing rates "fairly and accurately reflect the value of our patent portfolio." Qualcomm is again calling the bundle licensing agreements with the CMs and not the US government's heavy but fictitious SEP licensing FTC and Apple.
In conclusion, Judge Koh makes her decision in much the same way as earlier regulators. Nobody likes a bully, and no one likes Qualcomm threatening to withhold chips, so it's obvious. If it finds that Apple's contract manufacturers were also at risk, it could ask for a renegotiation of the licensing agreements, which is likely to be replaced by the new agreement between Apple and Qualcomm. Of course, Koh will also require the Qualcomm license to sell SEPs to competing chip makers.
What the long-term effects of this are remains to be seen. This can lead to a two-tier licensing program that includes separate license agreements with chip manufacturers and handset manufacturers that cover different bundles of SEPs and non-SEPs.
Kerrisdale's analysis focused on the business with Qualcomm's wireless modem and did not focus on another important part of Qualcomm's business, which are ARM architecture processors. These play a critical role in today's smartphone and other companies becoming increasingly important to Qualcomm, such as automotive infotainment, IoT and mobile Windows computing.
Kerrisdale also argued that Qualcomm's 5G modems are radio-wavelength specific and are only intended for operation at millimeter wavelengths. In fact, the Qualcomm 5G X50 modem is designed to operate on a variety of radio frequencies, including "sub-6 GHz" RF. The key point of 5G is "wavelength diversity", the use of a variety of radio frequencies and modulation formats to ensure the highest bandwidth data connection regardless of the environmental conditions under which the handset operates.
Qualcomm has the only working 5G modem and this modem will hit the market first this year. Qualcomm has built an extensive patent portfolio in 5G as a result of leading the development of 5G solutions and standards. It is difficult to assess the value of this part of the Qualcomm portfolio at the present time, but given Qualcomm's progress in marketing 5G modems for smartphones, I expect it to be significant.
Investor take away
I wish I could say that I've seen that coming, but it would only be partially true. I felt that Qualcomm would eventually prevail to defend his basic business model, but I thought it would be a longer, harder blog than it turned out.
I also thought that Qualcomm would probably be subject to fines and corrective action, part of a result of the FTC lawsuit, including a settlement. This will probably still be the case. I will not excuse the abuses and mistakes of Qualcomm in the past that were overt.
But the agreement with Apple is almost certainly a fundamental validation for Qualcomm and for future technology companies that generate significant revenue from licensing intellectual property. Apple's attempt to destroy Qualcomm's business model would have been bad for the semiconductor industry as a whole.
As the industry moves to the "new paradigm" of electronics manufacturers designing their own processors, tremendous wealth and power flow to them. Apple has not hesitated to use its wealth and power to recklessly outnumber its suppliers, and has completely eliminated intellectual property rights providers like Imagination Technologies.
In the new paradigm, IP is the precious commodity and the companies that offer this IP must thrive, otherwise innovation itself will suffer. The war between Apple and Qualcomm was called the cost of chips. It's so much more than that. It's essentially about controlling the evolution of IP.
Apple saw a need to control and bring wireless IP development into the house, especially for the 5G era, and tried this in the case of Qualcomm. An Apple win would have destroyed Qualcomm and brought the remnants of Qualcomm's development efforts to the Apple world.
Daniel Eran Dilger, who writes today in Apple Insider, argues that the real loser in the settlement is Android:
Suddenly The One or Two Years 5G Exclusivity – and Qualcomm Exclusivity – the Android makers and their media promoters were trying to turn themselves into a big problem – have disappeared in the void. Even analysts, including UBS, need to find another reason to fuel fears of Apple's future. All these months of trumpeting the news that Apple's best iPhones have a slight drawback have evaporated.
The settlement is not a victory for Android, but not the catastrophe that would have happened Apple had achieved its goals. Qualcomm is the main provider of chips for Android OEMs. The Android universe would have been significantly weakened without Qualcomm.
The settlement means that we will continue to see healthy competition between Android and iOS, and I think that's a good thing. Qualcomm, free of distraction and financial burden of the war with Apple, can now pursue its growth strategies unhindered. Qualcomm has long been part of the Rethink Technology portfolio (my personal portfolio, in fact), even though it has recently been rated a holdback due to more than a headwind.
Officially, it's still a hold, but I'll re-evaluate Qualcomm's future growth potential after the May 1 earnings report, if I hope investors will learn more about the deal.
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Disclosure: I am QCOM, AAPL. I wrote this article myself and expresses my own opinions. I can not get any compensation for it (except from Seeking Alpha). I have no business relationship with a company whose inventory is mentioned in this article.