Qualcomm (QCOM) and/vs. Apple (AAPL)

QCOM and its IP

QCOM is a company that has its roots in early Defense Department mobile communication and encription technology.  As a public company, it manufactures mobile chips itself and licenses its proprietary technology to others in return for royalty payments.  The latter, which has always been the prime focus of investor interest, comprises the bulk of its profits.  QCOM’s operating income for fiscal 2016 (ended September 25th) amounted to $6.5 billion, net $5.7 billion.  On a non-GAAP basis, each figure would be about $1 billion higher.

royalty dispute with AAPL

Last week, QCOM announced that AAPL, whose phone designs (like almost everyone else’s) incorporate QCOM intellectual property and who had been complaining that royalty rates were too high, has decided to cease making any payments to QCOM while the dispute wends its way through the courts.

As I understand the situation–and I’d bet this is a simplification of a set of very complex deals–AAPL doesn’t pay QCOM directly.  It designs phones that use QCOM’s IP.  The phones are made by contract manufacturers, who purchase the IP from QCOM.  AAPL reimburses them.

with China, too

This isn’t QCOM’s first quarrel with a customer.  In 2015, pressured by the Chinese government, QCOM agreed to pay a $975 million fine and lower its royalty rate on older technology in phones made for sale in China by a third.

implications for AAPL and QCOM

My question:  why is AAPL bothering?   Yes, it’s a lot of money.  And maybe it’s just that it wants to have the same reduction on the IP affected by the China deal.  But I can’t believe that it doesn’t have that already.

Look at the magnitudes involved:

QCOM says its next quarter revenues (and operating income) will be $500 million lower than expected because of AAPL’s action.  Annualized, that amounts to $2 billion, or about a third of QCOM’s operating income in fiscal 2016.

For AAPL, in contrastfiscal 2016 operating income was $60 billion.  Analysts are estimating 8% growth for the current fiscal year and a 15% advance the following one.

So cutting the QCOM royalty payments in half would only raise operating income by 1/60th, or 1.7%.

my take

One way of looking at this dispute is that AAPL believes it is running out of ways to make revenues grow and has to concentrate, for the moment at least, on cost control.  That’s the typical pattern.  It would also be more evidence that today’s model isn’t the Steve Jobs AAPL any more.