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Qualcomm gets $4.5bn and the iPhone deal; Apple in retreat in Q1

After quarters of doom and gloom among Qualcomm investors, about the financial cost and even existential risk created by the war with Apple, the tables are completely turned. The two companies have settled, with Qualcomm clearly coming out best; the chip provider has its iPhone contract back and has seen yet another challenger to its modem crown, Intel, driven off.

Meanwhile, Apple has turned in its worst iPhone quarter, with a 17% drop in the revenues from its core product. The decline is far worse than the 4% fall that the entire smartphone market experienced last year, and Apple has already been overtaken as the number two handset vendor by Huawei.

Not that these smartphone trends are good for Qualcomm either. Despite efforts at diversification, it remains very dependent on its core handset market. It is seeking to sell more and more components to smartphone vendors as the devices get more complex – not just processor/modem system-on-chip (SoC) units but graphical processors, AI and computer vision chips, RF front ends and more. But the winning back of Apple has come just in the nick of time, given that Huawei and Samsung, the world’s largest handset makers, are using more and more of their own chips, while higher growth vendors in China are more inclined to use low cost silicon from local sources.

But for now, Qualcomm can relish its victory, and the fact that it will book between $4.5bn and $4.7bn in third quarter revenues as part of its settlement with Apple. This sum will include overdue patent royalties, which Apple and its partners had suspended during the dispute, and Qualcomm’s release from obligations to the iPhone maker.

In a statement, Qualcomm said this one-off sum will more than double third quarter revenues. CEO Steve Mollenkopf said the deal “provides a lot of stability for our business. There’s a lot of tension removed from the system…as we work on products [and] find and maintain a good relationship”.

Qualcomm also hopes the Apple deal will encourage Huawei to sign a licensing agreement. The Chinese firm is the last major handset maker without such an arrangement. Qualcomm is calling for a return to a deal the two signed in 2014 in the wake of its settlement with Chinese antitrust authorities. In an interim deal, Huawei currently pays Apple $150m per quarter in royalties.

Despite the good news about Apple, not everything is rosy for Qualcomm. The chip giant reduced its 2019 handset forecast to about 1.85bn units, 50m units fewer than it previously predicted, mainly because of weakness in China and “lengthening of handset replacement cycles, and a possible pause before 5G” roll-outs.

This has been seen in some of the MNOs’ results too. Several operators have reported negative impact from slowing handset sales and longer replacement cycles lately. China Telecom recorded 4.5% year-on-year profit growth in its first quarter (turning in RMB5.96bn or $886m), but a sharp drop in handset sales led to a small decline in overall revenue, to RMB96.1bn. Sales of devices fell by 48.5% on the year-ago quarter even though the operator signed up 50m new mobile subs.

And in the first two months of 2019, AT&T took a sales hit of $50m a month because of slowing upgrade cycles for smartphones, according to CFO John Stephens. He told an investor conference that sales of mobile devices in the first two months totaled $2.3bn, down by $100m compared with the first two months of 2018. “Customers continue to hold [onto] their handsets longer,” he said, though he also noted that device prices have been increasing.

Qualcomm still faces one legal challenge arising from the Apple war. The Federal Trade Commission has brought a suit in San Jose, asking the court to bar Qualcomm from requiring a patent licence as a condition of selling its chips – one of the key points at issue with Apple (and others). If the result goes against Qualcomm, it could force it to change its business model in a fundamental way, and renegotiate terms with some of its customers. It could also be compelled to license its standards-essential patents to rival chip vendors under Frand (fair reasonable and non-discriminatory) rules.

Qualcomm may have won Apple back for now, but reports persist that the iPhone maker will look to develop its own 5G modem inhouse, as it has done with other key components such as the central processor and graphics processor. Of course, as Intel, Nvidia, Broadcom and others have found to their cost, developing a successful modem – and one that can perform as well as Qualcomm’s – is a tough challenge, in which a company is always up against the incumbent’s mighty store of patents and decades of design experience in this field.

However, Apple is nothing if not ambitious when it comes to controlling its supply chain, and according to UK reports, it has recently hired the lead developer of Intel’s 5G modem unit.

This was not a direct result of the chip giant’s decision to quit the field – the Sunday Telegraph said Apple hired Umashankar Thyagarajan (formerly senior director, project engineer 5G at Intel) to its Architecture team in February. Indeed, Thyagarajan’s departure may have been one factor in Intel deciding to exit the 5G smartphone modem market altogether following Apple’s settlement with Qualcomm.

In separate articles, The Wall Street Journal quoted sources who said Apple opened talks with Intel about acquiring its smartphone modem chip outright in 2018, but the discussions were later abandoned amid reports that Intel had fallen behind in developing its modem.

It is more important than ever that the 5G iPhone has a significant impact and performs as well as possible, given the decline in the current portfolio’s sales. Apple’s CEO Tim Cook and CFO Luca Maestri tried bravely to talk up the non-iPhone devices – the strongest iPad growth in six years in its fiscal Q2 (to March 30), with reveue up 22% year-on-year to $4.9bn; wearables up almost 50%.

Revenue in the Wearables, Home and Accessories segment grew 30% year-on-year to $5.1bn. Services, which has been the main bright spot in recent quarters in the face of iPhone slowdown, turned in a good performance again, with revenue up 16% to $11.5bn.

But none of this really distracted from the fact that the company is massively over-reliant on one star product, and the iPhone’s revenues were down 17% to $31.1bn, pushing total company revenue down 5% to $58bn, with a fall in net income to $11.6bn, from $13.8bn in the year-ago period.

Cook insisted the iPhone would soon bounce back, pointing to November and December as the lowest point for the device and promising that price cuts and trade-in programs – especially in price-sensitive but large markets like India – are already starting to take effect. He said trade-in volumes for the March quarter were four times what they had been in fiscal Q2 2018.

But on the other side, The Information reports that one of Apple’s most senior wireless engineers, Rubén Caballero – VP of engineering in charge of wireless – quit in the wake of the Qualcomm settlement. That suggests that Apple might have abandoned its own 5G plans, at least for the short term; or that executives who had supported the Intel collaboration were pressurized to quit once that had turned sour and failed to deliver the hoped-for results.

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