The pattern of Qualcomm news is becoming repetitive. First a negative ruling on some aspect of intellectual property rights (IPR) ‘ quickly followed by yet another odds-defying upgrade to the chip giant’s financial fortunes. The past week has been no exception ‘ early on we heard Qualcomm trying to downplay the impact of a US Supreme Court ruling limiting multiple royalties on the same patent, a decision against which Qualcomm had lobbied intensively before, saying it could impact ‘significantly and fundamentally the foundations of Qualcomm’s business’. Then the company issued yet another upgrade to its financial forecasts, citing strong growth in 3G systems, and coming only a week after rival Texas Instruments narrowed its own quarterly estimates.
While Qualcomm may grasp market share in the 3G markets on a quarter-by-quarter basis, dark clouds still loom on its horizon and it will have to ramp up its efforts still further to protect itself from the medium term effects. Some involve new competitors, notably the rejuvenated Infineon, whose 2G and/or 3G basebands are appealing to handset makers’ cost cutting instincts and have found favor with Apple, Nokia and now with a key Qualcomm customer, Samsung, which has claimed the German chipmaker is offering prices 20% better than those of its US rival.
While such developments will put pressure on Qualcomm’s pricing and margins, they are part of the normal competitive environment to which the giant has been adjusting fairly effectively since emerging from its CDMA cocoon and taking on the open playing field in the former GSM world, as that moves to 3G and beyond.
Where Qualcomm’s ability to respond to new circumstances is less clear is on the licensing side of its business, and here its opponents, led by Nokia and its henchmen TI and Broadcom, claim there is still no level playing field, because of Qualcomm’s practises for licensing the large number of patents it holds in W-CDMA, HSPA and elsewhere (even, if we are to believe the hints, in OFDM-based emerging systems like WiMAX and LTE).
Qualcomm has won some stages in its battles over the past year or more, and lost more, but the key test case is with Nokia, not only likely to set precedents on licensing practises and rates, but also help decide whether the two behemoths can settle their stalemate over the fees that Nokia will pay its rival for patents. Since their previous agreement expired in April 2007, Nokia has been refusing to pay the royalties demanded by Qualcomm, instead putting aside the funds for a reduced payment, based on the level it believes to be fair, given market changes and its own claims to increased IPR in 3G.
The key case in this long-drawn out battle should start to be heard next month, and in the meantime, Qualcomm has suffered another legal blow, this one dealt by the US Supreme Court. On Monday, the Court limited the ability of patent holders to extract royalties from companies at more than one stage of the production process, a controversial habit known as double-dipping, which is one of the issues over which Qualcomm and its opponents fight. The new ruling was prompted by a lawsuit between different antagonists ‘ LG Electronics had brought the case against Quanta Computer of Taiwan, but had its claims thrown out by the Supreme Court justices. These judges ruled that LG could not extract royalties on its memory technology patents from PC maker Quanta, because it had already taken royalties on the same patents from Intel, whose chips are inside the PCs. Therefore the power to extract fees was ‘exhausted’ by the Intel agreement ‘ an argument that is central to the licensing suits and countersuits between Qualcomm and Nokia.
LG “licensed Intel to practise any of its patents and to sell products practising those patents,” Justice Clarence Thomas wrote for the court. Intel’s sale of its chips “thus took its products outside the scope of the patent monopoly’. The ramifications of this case do not just affect the PC industry but could help to clarify a knotty issue in the mobile market. Among the vendors supporting Quanta were not only computer firms HP, Dell, IBM, Cisco and NCR, but also Nokia and Motorola, while those lobbying on LG’s side were Qualcomm, backed less predictably by Yahoo.
The ruling reversed a decision by the US Court of Appeals for the Federal Circuit in Washington, which specializes in patent law. The appeals court had said LG’s infringement suit could go forward, reversing a previous ruling. LG said it required Intel to notify its customers that the chipmaker could not license them to combine the chips with other computer components.
Before the ruling, Qualcomm had been well aware of the potential knock-on effect of such a ruling on its own business. It said in one of its submissions to the hearings: ‘Non-trivial changes to the controlling interpretation of US patent law have the potential to affect significantly and fundamentally the foundations of Qualcomm’s business (and those of other high technology companies)’, by expanding ‘the bounds of the exhaustion doctrine in a way that potentially would render Qualcomm and other patent owners unable to receive royalties in an amount commensurate to the significant economic value of their innovations by efficiently dividing and restricting rights granted at different stages in the chain of production.’
Afterwards, of course, Qualcomm sought to downplay the Supreme Court decision, despite its previous dark predictions. ‘Unlike the license agreement at issue in the Quanta case, Qualcomm’s agreements limit the rights granted in order to prevent patent exhaustion. Therefore, we do not expect this decision to impact Qualcomm’s business,’ said a spokesperson. But specialist analysts at Stifel, Nicolaus & Co said they viewed the ruling as bad for Qualcomm. ‘The decision affects all players in industries with downstream component sales such as semiconductors, computers and wireless handsets,’ they wrote in a research note this week. They believe the US judgement has gone a lot further than previous cases to establish a general principle that the first buyer of a patent should pay the royalty in full and pass the cost onto consumers, and that double-dipping should not be allowed to be built into patent holders’ agreements with their customer chains.
‘The Supreme Court has made it much more difficult for a patent holder to take a second ‘bite at the apple’ after getting royalties from a component supplier for a license,’ Paul Jahn, a partner in law firm Morrison & Foerster, told silicon.com. ‘If the supplier’s product constitutes a material part of an invention, the patent ‘ whether apparatus or method ‘ is exhausted. To avoid exhaustion protecting downstream vendors and customers, a license now needs to limit the component vendor’s authority to sell its own product. The court has reinforced the patent exhaustion doctrine and turned back efforts to ‘chip away’ at its edges.’
However, unlike some analysts, Morrison & Foerster see no reason why some patent holders should not be able legally to circumvent the new ruling. ‘We see nothing in the court’s decision today that restricts the patent holder from contracting around the patent exhaustion doctrine by expressly limiting the licensee’s ability to sell downstream so that the patent holder can collect downstream royalties,’ said Stifel. ‘But as a practical matter, this has not been the preferred business practice because it requires collecting a greater royalty at the first point of sale.’
The more Qualcomm gets besieged over its IPR policies – and the more likely it becomes that these will have to change over the coming years, with a resulting impact on margins and market control ‘ the more the company’s core business of chip design fights back to grasp leading edge innovations and market share in W-CDMA/HSPA and other high growth or emerging technologies, technologies that will be key to compensating for the eventual decline in the CDMA chip business that Qualcomm all but owns.
So Qualcomm has faced the fears of reduced consumer spending and heightened 3G competition from the likes of Infineon, and last week came out with boosted forecasts for the current quarter, ending June 29, and for the full fiscal year. The company said it now expected revenue for the quarter to be “slightly above” the high end of prior guidance of $2.5bn-$2.7bn, and earnings to come in at 54-55 cents a share, rather than the 50-52 cents previously forecast.
‘We are expecting another successful quarter driven by the continued global migration to 3G,” CEO Paul Jacobs said. ‘March quarter reports by our licensees indicate an increased mix of high end devices driving a higher average selling price.” For the full year, Qualcomm now sees earnings of $2.09 to $2.13 a share, above its earlier forecast of $2.04 to $2.09 a share.
This came just days after Texas Instruments, in a mid-quarter update, warned of a weakening market environment and talked of plans to reduce its dependence on digital wireless chips, chasing increased share in analog and entertainment. TI narrowed the quarterly earnings and revenue target range it had issued in April because of caution among its chip customers and weak demand for high end phones, and now forecasts second quarter earnings of 43-47 cents per share on revenue of $3.33bn-$3.46bn. “There are a couple of areas where we are seeing weakness, one of which is wireless handset revenue, which continues to be unseasonably weak and we would expect that it’s probably going to be down a little bit from the first quarter level,” said TI’s head of investor relations Ron Slaymaker. “Another area would be processors, which are running weak for the quarter.” On April 21, TI disappointed investors with a forecast for earnings of 42-48 cents per share on revenue of $3.24bn-$3.5bn.