The ongoing licensing issues in China have muted Qualcomm’s (QCOM) results to some extent and it is expected that the effect of this issue will be seen in the coming quarter as well. Beijing is on a massive anti-monopoly probe against a number of foreign companies, of which there are a reasonable number of US based companies. This issue also puts Qualcomm’s agreement with leading Chinese telecom companies like Huawei, ZTE and Xiaomi. In fact, Qualcomm only recently pushed NVIDIA out of Xiaomi's recent product Mi4. NVIDIA's Tegra 4 shared the spot with Qualcomm in the previous Mi3, but Xiaomi has gone exclusively with Qualcomm in the Mi4.
The crisis looms
Continuing with the above-mentioned point, it is no stranger to us that the Chinese Government is following several probes against a good number of foreign companies on account of unfair trade practices. With Qualcomm as well, a similar story is taking place. The U.S. chipmaker has been facing a probe by Chinese antitrust authorities into whether it holds monopoly power there. Chinese authorities have disclosed little about the nature of the probe, so its full scale isn’t clear yet. As per reports, Qualcomm’s licensing business is suffering on account of a dispute with Qualcomm licensees, under-reporting by certain licensees and on sales of certain unlicensed devices in the region.
China has become a highly strategic market for most of the smartphone makers because of its large population and comparatively better economic strength. Therefore, it is not surprising that Qualcomm is also attempting hard in order to resolve the crisis in China. While, the crisis might be resolved soon, there is another problem that might creep up adding to this probe. The Chinese regulator could demand Qualcomm to terminate its so-called “reverse patent license”, a mandatory agreement that the company imposed on its clients to lift their patent fees to each other.
For now I will skip getting deep into understanding the mechanism of this agreement, but the significant thing to understand is that such an agreement shields interests of smartphone makers with fewer patents as they do not have to pay any relevant patent royalties to other bigger Qualcomm clients. This is the reason that analysts are concerned this probe will hit the interests of Xiaomi. Though Xiaomi has been hugely successful in creating a lasting impact on Chinese smartphone market and toppling giants like Samsung and Lenovo, the company has comparatively lesser patent rights.
Consider this: by the end of 2013, ZTE's patent total has exceeded 52,000 patents worldwide, while Huawei's total patent portfolio numbered over 30,000 by November this year. In stark contrast, Xiaomi owns a total of just 10 patent rights. Again, there is no clear idea whether the Chinese regulators will take up the “reverse patent license” in its probe but investors need to be certain that Qualcomm will have a tough time battling this Chinese crisis and this will create a dent on its upcoming earnings as well.
A volatile journey
Qualcomm’s trajectory has been highly volatile in the past twelve months owing to these regulatory issues and as a matter of fact, the shares have lost approximately 5 percent since it announced its quarterly earnings on November 5th. Qualcomm has been a subject of some headwinds and negative news overall. A while back there was a flurry of media reports stated that their upcoming Snapdragon 810 SoC had hit a snag or two and that it would be late to market. However, Qualcomm has refuted these claims and assured investors and loyalists that the progress of Snapdragon 810 is on track and it will be released as decided.
Takeaway
Coming back to Qualcomm’s share price movement, the past few months have been considerably volatile and now that the company has released softer than expected guidance, one can expect that things will stay rocky for now. Going by the numbers, Qualcomm is still a justified buy with a forward multiple of approximately 12.7. However, the crisis in China is a big deterrent and if the entire probe materializes, it is expected that Qualcomm might have to shell out around $1.2 billion in fines. This implies $0.73 per share will be lost as a result of this crisis. Additionally, the agreements that Qualcomm has with most Chinese vendors will be in jeopardy if the regulatory authority picks up so-called patent peace provisions. To sum it up, Qualcomm is definitely a stock with good fundamentals but there is too much ambiguity that clouds its operations and therefore, investors should be mindful while investing in the stock.
