InterDigital Inc (IDCC)

[Gamco]

Apple Could End Qualcomm Row With $8 Billion Payment

Apple could digest a payment, and an ongoing rate of $5.90 per phone as could be acceptable to both parties.

Aug. 7, 2017 11:20 a.m. ET

Credit Suisse

Following an analysis of legal filings and previous intellectual-property (IP) disputes, along with feedback from industry experts, we look at the nature of the current dispute between Apple and Qualcomm.

We see merit in both parties’ arguments, and believe mutual self-interest will prevail, making it unlikely that this dispute will result in prolonged litigation or court trials.

Apple (ticker: AAPL) needs Qualcomm (QCOM). First, the current non-paying contract original equipment manufacturers (OEMs) are under license, and we believe it is unprecedented to withhold payments with an agreement in place. Second, Qualcomm is a key driver of wireless intellectual property rights (IPR) in 2G, 3G and 4G and will be a key contributor to 5G. As a result, Apple products will continue to leverage Qualcomm’s innovations, both for standard essential patents (SEP) and for IP in components, such as battery and screen technology, just to name a few. Third, although Apple may seek to lower its chipset dependence over the long term, we do believe it will require supply over the next few years, especially with the onset of 5G.

Qualcomm needs to resolve this. First, as the largest mobile OEM with hardware revenues of $190 billion, Apple is simply too large to ignore. Second, given that Apple is set to gain market share in a non-growing smartphone industry, Qualcomm will be eager to settle this matter. A lack of exposure for Qualcomm means a declining total available market (TAM) over the next few years. Third, taking this to trial could result in an outcome that affects Qualcomm’s other agreements. The recent Lexmark ruling could also, if applied in this case, represent a risk.

Mutual self-interest will prevail, settlement is possible. We believe, as in the agreements between Qualcomm- Nokia (NOK) and Qualcomm-Samsung in 2008 and 2009, respectively, that an amenable settlement for both parties is possible. This would likely result in a major upfront payment and a heavily discounted royalty rate. It would also likely leave open the possibility of these companies collaborating in other areas, such as digital health, Internet of Things (IoT), datacenters, etc. Apple could digest a payment given its cash balances and would welcome a minimal hit to its gross margin, while Qualcomm would welcome upfront revenues. We see an upfront payment at $8 billion and ongoing rate of $5.90 per phone as possibly being acceptable to both parties.

Ultimately, the dispute with Qualcomm increases some risk to Apple; however, we believe it is moderate. We remain convinced that the iPhone 8 product cycle will be significant in terms of driving multi-year unit growth, and we maintain our conviction on Apple’s ability to introduce new higher pricing tiers with an improved mix. This, along with the Services growth, should offset higher bill of materials (BOM) to support gross margins, driving calendar 2017/2018/2019 earnings-per-share estimates to $9.61/$11.89/$13.11, respectively. We reiterate our Outperform rating and price target of $175.

We see limited competitive options in the premium LTE market, apart from Qualcomm and Intel. This becomes especially important with 5G roll-outs beginning in 2018, as Qualcomm has a close alliance with almost all major 5G carriers. We conclude that Qualcomm has a robust portfolio based upon Qualcomm Technology Licensing’s (QTL) 30,000-plus declared patents and its non-standard essential patents (SEP) strength, along with the need for backwards compatibility.

Currently, we note that neither Apple nor, we believe, Huawei are paying Qualcomm. Given these vendors account for about 24%/43% of smartphone volume/Qualcomm total royalty device sales (TRDS), QTL revenue could be materially understated for the long term.

http://www.barrons.com/articles/apple-could-end-qualcomm-row-with-8-billion-payment-1502119206