Qualcomm May Face Strict Patent and Royalty Rule in China - Analyst Blog

According to a recent Bloomberg report which quoted an unidentified source, Qualcomm Inc. (QCOM) may need to accept lower royalty payment for its technology licensing in China. Qualcomm, the largest manufacturer of wireless chipset globally, is in deep trouble in China.

On Nov 2013, the Chinese regulatory authority, National Development and Reform Commission (NDRC), had initiated a probe on the company related to its monopolistic practices. Following that, the NDRC determined that Qualcomm is exercising monopolistic power in the country.  

China provides a major growth opportunity to Qualcomm as the high-end smartphone and tablet industry is gradually reaching saturation in developed countries. Meanwhile, all the Chinese telecom operators, namely, China Mobile Ltd. (CHL), China Unicom Ltd. (CHU) and China Telecom Corp. Ltd. (CHA) have ramped up the deployment of 4G LTE (either TDD or FDD format) networks, opens up significant scope for Qualcomm's future growth.   

The company is currently involved in a royalty dispute with a major customer in China. Moreover, a few small companies haven't agreed on a royalty payment as the NDRC is yet to come up with its decision. A few companies are also under-reporting the number of phones sold, for which they should have ideally paid license fees.

In the meantime, low-end 3G tablets are gaining huge market traction in China. However, there is a vast distinction between tablet developers and smartphone developers in China. For that, Qualcomm needs to enter into new licensing agreement with tablet developers.

Qualcomm generates approximately 29% of its total revenue from the licensing business however, this business accounts for almost 77% of the company's net profit. China – the largest emerging market – contributed approximately 49% of Qualcomm's total revenue in fiscal 2014 (ended Sep 2014). Accordingly, industry observers feel that the company will have to pay a hefty fine and may also have to face a cut in royalty fees.

Over the last five years, Qualcomm generated approximately $30.5 billion in licensing revenues. Bloomberg also reported that the company was willing to incur a higher fine (one-time penalty) in order to keep its royalty rate unchanged. However, the Chinese authorities invalidated that proposal.

A major cause of concern for Qualcomm at present is that other countries may also adopt stringent licensing norms like China to help their indigenous handset developers. The company might also have to forego royalties of TDD-LTE as a settlement. Such unfavorable actions will severely impair Qualcomm's patent portfolio and consequently its whole business model. Qualcomm currently carries a Zacks Rank #3 (Hold).