InterDigital Inc (IDCC)

[Gamco]

Takeover saga between Broadcom, Qualcomm may hinge on changes in patent licensing

November 23, 2017, 6:00 AM

A key battlefield in Broadcom’s $103 billion bid to acquire Qualcomm is how to fix the San Diego chipmaker’s besieged patent licensing division.

Analysts have begun speculating on how Broadcom Chief Executive Hock Tan might change Qualcomm’s patent licensing model to end lawsuits with Apple and antitrust regulators.

One of the more dramatic scenarios was floated by Bernstein Research Analyst Stacy Rasgon in a recent report. He sees Qualcomm and Broadcom as having diametrically opposed world views on the future of Qualcomm’s patent licensing business.

“Qualcomm is saying this whole thing sucks, but it is a blip,” said Rasgon in an interview. “We have the high ground. Eventually we will win (against Apple and regulators in court) and it will go back to the way it was.

“And Hock is saying you guys are dreaming,” Rasgon continued. “It is never going to come back.”

Citing conversations with Broadcom management and investors who have spoken with them, Rasgon believes Tan would scrap Qualcomm’s model of treating patents and chips as two separate products.

Instead, Tan’s strategy would be to marry patent licensing into chip pricing so smartphone customers would make one payment.

He would make up for any lost revenue by entering into long-term chip supply agreements with top smartphone makers and cutting costs – potentially as much as $3 billion annually – out of Qualcomm’s administrative and research expenses.

“Broadcom outlined to us their view that customers are no longer willing to stand for Qualcomm’s chipset-plus-licensing model,” said Rasgon. “We believe they are in fact prepared to, in some sense, abandon it.

“In short, we believe Hock intends to basically throw (Qualcomm’s technology licensing) to the wolves because he thinks they are going to eat it anyway, but use the action to significantly strengthen their chipset positioning and negotiating power, supported by significant spending cuts,” said Rasgon.

Qualcomm declined to comment. Broadcom has not specifically said yet how it would fix the legal troubles with Apple and antitrust regulators surrounding Qualcomm’s patent licensing business, which accounts for the bulk of the company’s profits.

“This is early stage to dig deep into it. I am sure there are various ways,” said Tan in a recent interview with the Union-Tribune. “The main thing we believe is we can approach this very constructively to resolve all these issues in their model with both their customers – which will also be common customers of ours – as well as regulators.”

Qualcomm’s board of directors has rejected Broadcom’s $70 per share offer as dramatically undervaluing the company. Tan said he is still interested in acquiring Qualcomm, possibly setting the stage for a hostile proxy fight for board seats. Qualcomm’s annual meeting is set for March 6.

Qualcomm has two businesses. It sells chips used in smartphones and other devices, and it licenses its portfolio of 130,000 mobile patents for a fee to device makers based on the price of the device. Royalties top out at 5 percent, though per-device caps and other measures usually result it smartphone makers paying much less.

Qualcomm’s model fosters competition in smartphones. Instead of keeping its patents to itself to block competitors, Qualcomm shares its inventions for a fee. That allows smartphone makers to quickly roll out new gadgets without having to invest billions to invent rival cellular technologies that don’t infringe on Qualcomm’s patents.

With the explosion of smartphone sales globally over the past decade, Qualcomm’s licensing division swelled to nearly $8 billion in revenue prior to its legal troubles.

But some smartphone makers chafe at Qualcomm’s model, which they contend forces them to pay twice – once for the patents and again for the chips.

Apple, which has stopped paying patent fees to Qualcomm this year, sued in January, alleging the San Diego company’s model violates patent law, among other things.

Antitrust regulators contend Qualcomm’s business practices force smartphone makers – who rely on the company’s modem chips – into accepting exorbitantly high patent fees for fear of losing chip supply.

These legal troubles have resulted in lower licensing revenue -- $6.4 billion in fiscal 2017 -- and a slumping stock price that made Qualcomm vulnerable to a takeover attempt.

Research firm Strategy Analytics noted that Qualcomm’s chip business is performing well. Its efforts to diversify into new markets beyond smartphones are beginning to pay off. That diversification will increase if it completes its pending $38 billion acquisition of NXP Semiconductors, which could occur in the next couple of months.

And with the upcoming transition to 5G networks, Qualcomm has a technology lead on competitors. That sets the stage for future growth as a stand-alone company.

Broadcom, on the other hand, could be hamstrung when 5G rolls out if it fails to acquire Qualcomm because it lacks a cellular modem product line, wrote Stuart Robinson and Sravan Kundojjala of Strategy Analytics in a research report.

“We think Broadcom needs Qualcomm more than Qualcomm needs Broadcom,” they wrote. “Qualcomm already has a clear path ahead.”

For Qualcomm shareholders, who ultimately could decide its fate if the bid goes hostile, Broadcom’s viewpoint that patent licensing revenue will further decline as more customers push back is a scary proposition, said Rasgon.

“If you are a shareholder and you think NXP is going to be good and they are eventually going to win with Apple, then you would want to hold,” said Rasgon. “But shareholders walking out of those meetings with Hock must be terrified. He is walking in there saying you guys, your models are wrong. It is going to get worse from here. I am your only hope.

“It is in his interest to scare shareholders,” added Rasgon. “I don’t know which one of them is right in terms of where this business is going. But he is putting his money where his mouth is."

http://www.sandiegouniontribune.com/business/technology/sd-fi-qpatents-broadcom-20171123-story.html