Qualcomm Faces Serious Patent, Royalty Issues in China

Qualcomm Inc. QCOM, 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 practice. Recently, a state-run Chinese news paper stated that the NDRC has determined that Qualcomm is exercising monopoly power in that country.

Just a couple of days ago, Qualcomm reported strong financial results for the third quarter of fiscal 2014. Both the top and the bottom line significantly outpaced the respective Zacks Consensus Estimate. 

Management stated that the company is facing near-term challenges related to its licensing business in China, and accordingly lowered its profit forecast for the ensuing fourth quarter of 2014. As a result, the stock price of Qualcomm fell6.7% over the last two trading sessions.

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

Meanwhile, the low-end 3G tablets are gaining huge market traction in China. However, tablet developers are completely different from smartphone developers in China. For that, Qualcomm needs to enter into new licensing agreement with them.

The Chinese newspaper also reported that if found guilty, Qualcomm will have to pay a hefty fine and will face a cut in royal fees. Qualcomm generates approximately 29% of its total revenues 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 2013 (ended Sep 2013). Accordingly, industry observers project that Qualcomm may need to pay a significant $1.2 billion or more in fine. More importantly, the company might also have to forego royalties of TDD-LTE as a settlement. Such unfavorable actions will severely impair Qualcomm's patent portfolio. 

Qualcomm is clearly the undisputed leader in the global wireless baseband chipset market. According to a recent research report by Strategy Analytics, in the first quarter of 2014, Qualcomm dominated this market with approximately 66% of the revenue share, followed by 15% of MediatekInc. and 5% of Spreadtrum Communications. Two other major players in this field are Marvell Technology Group Ltd. MRVL and Intel Corp. INTC.

Nevertheless, recent regulatory problem in China is a major blow to Qualcomm. In the meantime, China Mobile Ltd. CHL, the largest Chinese wireless operator, together with China Unicom and China Telecom, are gradually deploying 4G TD-LTE network which was considered Qualcomm's significant future growth potential. Qualcomm currently carries a Zacks Rank #3 (Hold).

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