Qualcomm Inc.: China Ruling: Flexing the Non-Essential IP Muscle
10 Dec 2024 -
China ruling (see Injunction Against Sale of Legacy iPhones in China Mostly Headline Risk For Now) highlights the potential of non-essential IP. To date most of Apple’s legal cases and strategic positioning have been focused on its claims that QUALCOMM is inappropriately levering and charging royalties on its essential IP portfolio. We think QUALCOMM likely has some legal advantages in essential IP-based arguments because courts generally have been reluctant to assign a value or royalty rate level to the concept of FRAND—fair, reasonable, and nondiscriminatory— for essential IP, while most other handset companies have negotiated essential IP FRAND rates bilaterally with QUALCOMM for more than 20 years. But we think QUALCOMM’s biggest advantage in its legal disputes with Apple lies in non-essential IP. Non-essential IP typically is not subject to FRAND considerations (e.g., theoretically, patent holders of what is deemed non-essential IP can demand any size payment and/or condition), and we believe that QUALCOMM has a substantial non-essential patent portfolio that likely covers a wide range of key mobile functionalities, including UI, displays, cameras, app stores, etc. We believe that China’s sales ban, based on what appears to be non-essential IP, should bode well for QUALCOMM’s efforts to counter Apple’s claims by asserting non-essential IP. Further, the ruling in China may give QUALCOMM more leverage to eventually collect incremental royalties from Chinese OEMs whose licensing agreements have only covered essential IP for the past few years.
China ban applies to all older models. QUALCOMM announced that iPhone models launched before 2018 would be banned from sale in China due to patent infringements. In response, Apple announced that all phones were still for sale in China, noting the injunction only ruled against phones running on a prior version of iOS (iOS11 or earlier), while QUALCOMM claims the ban applies to all phones regardless of iOS version. Apple models covered in the ban include all models from iPhone X or earlier; the newer models released in September 2018 (Xs, Xs Max, XR) are not included in the ban ruling, but we would expect QUALCOMM to move to have the courts find that those newest models are also infringing products and should also be banned. There is no additional review of the ban before it becomes effective. This afternoon, Thomson Reuters released news that AAPL has filed a request for the Chinese court to reconsider the ban, but an appeal will be to the same court that imposed the ban — it does not go to another/higher court for review.
This ban is based on 2 patents asserted by QCOM, with additional China court cases that could also impose bans covering another 20 patents. While this ban pertains to a fraction of the total patents asserted by QCOM, more than half of the remaining 20 patents have already been ruled to be valid by Chinese courts. (ie, there will be no debate in court as to whether those already vetted patents are valid), so most future arguments will be whether Apple products infringe QUALCOMM’s patents.
If Apple continues to sell phones in China, it will be up to QUALCOMM to make the courts aware. The court does not have a large number of enforcement personnel to assure that its rulings are not being violated. Instead it will largely be up to QCOM to bring accusations to the court that AAPL is selling phones in violation of the bans. Earlier today, CNBC reported that Apple phones were still for sale in China.
There is another case in Germany to be ruled on next week. It is also expected that a German court will rule on QUALCOMM’s request that iPhones be banned for sale in Germany. To date, German courts have declined to grant a sales ban based on 2 patents. As of now there are about 12-13 other patents that QCOM is asserting for which they are looking for an iPhone sales ban in Germany, with next week’s ruling likely to cover 2-4 of those patents.
We are EW with a $55 PT. We have highlighted favorable settlements with Apple as a potential catalyst to QCOM, and our Bull case of $75 factors in Apple’s return to being fully royalty compliant with some chip share coming back to QUALCOMM. We think Qualcomm will ultimately be successful against Apple, and today’s headline is a positive indication of the likelihood of that outcome. Our base case PT of $55 is 9x FY20 EBITDA, in-line with our coverage universe on a growth adjusted basis, which we think is appropriate balancing ongoing risks to the model with optionality stemming from an eventual resolution to the licensing business. We would turn more positive on the stock with more positive legal developments and receding risk that other OEMs may choose to withhold royalty payments, while we would turn more negative on the stock should handset demand continue to erode throughout 2019.
The authors of this material are not acting in the capacity of attorneys, nor do they hold themselves out as such. This material is not intended as either a legal opinion or legal advice. The information provided herein does not provide all possible outcomes or the probabilities of any outcomes. The result of any legal dispute or controversy is dependent on a variety of factors, including but not limited to, the parties’ historical relationship, laws pertaining to the case, relative litigation talent, trial location, jury composition, and judge composition. Investors should contact their legal advisor about any issue of law relating to the subject matter of this material.