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QualComm: The Margins

Posted on Friday, Sep 21st 2007

By Vijay Nagarajan, Guest Author

In the first part of this series, “QualComm: Legal Battles galore”, we looked at the legal events involving QualComm this year. We further looked at the significance of these events in “QualComm:The aftermath”. In this piece, I shall delve a little deeper into the impact of the legal battles and any further reversal that QualComm (QCOM) may suffer, by taking a look at the company’s financials for 2006.

The year 2006 saw QualComm’s revenues grow to $7.53 billion at a gross margin of 71% and an operating margin of 36% (down to 32.5% TTM). The company made $4.78 billion selling chips and services, primarily attributed to the QualComm CDMA Technologies (QCT) division, while licensing and royalties resulted in $2.75 billion. The QCT operating margins stood at 26% (higher than the industry average of 14%) while QTL margins were as high as 90%. A numerical analysis of this data along with CDMA-based chipset shipment volumes during this period reveals interesting data-points –

  • Average royalty/licensing fee per CDMA-based handset sold (including CDMA2000, WCDMA/HSDPA, EV-DO) is $11, about 5% of handset average selling price (ASP).
  • Average price per IC is $24 (11% of CDMA-based handset ASP).

With these numbers, we can evaluate the impact of legal reversals on the company’s business model-

  • Verizon’s deal with BroadCom gives the latter $6 per handset sold (2.8% of handset ASP). If this serves as a precedent for deals that companies hope to strike with QualComm in the future, it spells trouble for the San Diego company. For example, if it pays a $5 royalty on the estimated 300 million chipsets for 2007, its gross margin is expected to come down from the consistent 70% mark to around 58%. The corresponding QCT operating margins will come down to single-digits. Though higher than the industry average of 50%, the projected gross margin signifies the impact on the IP business model. Continued reversals will thus make QualComm a more typical semiconductor company.
  • Each dollar shaved off the IC selling price will result in the gross margin going down by about 1.5%. The corresponding QCT operating margins will be 4.5% lower.

This would then call for a reduction in the 20% R&D budget to buttress the operating margin – a paradigm shift from its business model. Further, it needs to capture more of the market to increase volumes. This implies investigation into new technologies, features and highly integrated products ahead of the competition.

In subsequent articles, we will look into the various technologies and technological directions that may influence the outlook and business model of QualComm and how the company is already looking into some of these aspects on the engineering side.

This segment is a part in the series : QualComm

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Are you taking into account any money that fraudcom (sorry broadcom) has to pay to QCOM for licensing the wcdma portfolio? Also what about the recent stay on the downstream remedy?

vee Saturday, September 22, 2007 at 3:20 PM PT

Vee, the analysis here assumes that all else remains the same and is just an indication of where things would be headed if QualComm were to decisively lose one or two of its legal battles (not just with BroadCom). Also, it does not suggest that QCOM will lose the ITC ban appeal. The current stay is merely a reprieve to the handset vendors/carriers caught in the cross-fire and still does not exempt QCOM from paying royalties to BRCM. The final appeal ruling will provide us that answer.

Vijay Saturday, September 22, 2007 at 7:26 PM PT

Re:- “Verizon’s deal with BroadCom gives the latter $6 per handset sold “

Not exactly!! There is a $ cap per qtr and lifetime. When figuring in the cap, it is estimated that the figure comes down to $1 per handset. QCOM also stated they were never offered that “deal”. Further the BRCM patents expire in less than 2 years.

jim mullens Sunday, September 23, 2007 at 11:40 AM PT

Jim,

Thanks for your note. I do understand the $40 million per quarter, $200 million life-time cap on the Verizon deal. Also, the deal is for all six patents in dispute as against the ITC patent alone for which BRCM was seeking $6 royalties from QCOM. The ITC patent expires in mid-2010. So, if in 3 years, Verizon sells more than 35 million of the disputed EV-DO handsets and QualComm does not have a quick and fool-proof work-around, the royalty per chip will be below $6. There are a few things I will point out though-

  1. It is a different ball-game with Verizon than with QualComm. This deal gives BroadCom traction with the carrier. It is to be noted that along with this license, BRCM also entered into strategic agreements with Verizon on complementary technologies as GPS, Bluetooth and WLAN all of which QCOM also has the capabilities to produce now. So a ‘sweet’ deal makes sense. The same does not hold good for a direct deal with QualComm. For BroadCom, the law-suits are ploys to undermine QualComm’s IP value thereby reducing the royalties the latter seeks from BRCM on 3G shipments.
  2. Again, the point to note is that the trends,not any individual lawsuit, bode bad news for QCOM (the point I was making in my previous article). I intended to illustrate with some representative numbers, how other companies (not just BroadCom or Nokia) envision breaking QualComm’s business model to improve their own margins from 3G sales.
  3. The royalty rates that QualComm may finally have to pay to BRCM or Nokia or anyone else may not be fixed dollar amounts like in Verizon’s case and is likely to be hidden in cross-licensing deals with a lower net inflow to QualComm. That effectively cuts the margins for QCOM, the difference being that it will be from QTL rather than from QCT. In other words, we can either look at the losses as reduced margin per chip that QualComm produces or reduced royalty that it seeks from the parties it is in dispute with.

Thanks,
Vijay

Vijay Sunday, September 23, 2007 at 10:58 PM PT

Broadcom collects $6 per phone for 4 patents. Can Qualcomm argue that it will collect $60 per phone for 100 patents? Then collecting $11 per phone with hundreds of patents in WCDMA/CDMA sounds very reasonable then. How can they lose this kind of argument?

Graham Graham Monday, September 24, 2007 at 2:20 PM PT

Its’s worth taking into consideration the bad blood that Qualcomm has created through its’ business practices and acitivities in standards bodies . A good example being Motorola ditching Qualcomm as a chip vendor earlier this month citing “business rather than engineering” reasons. This will surely effect their bottom line considerably. Similar attitudes (avoid Qualcomm whenever possible) will effect all areas of Qualcomms activities.

Seth Tuesday, September 25, 2007 at 8:21 AM PT

Graham, $6 for as many patents yet completely proven to be infringing is perhaps a fortune. But the argument will be made around ‘essential IP’, something that is subjective based on which company we talk to. Again, the bottomline is that the $6 is a means to lower QualComm’s IP value. And of course, for QualComm’s own good and practicality, $60 is out of question, even for the sake of argument. It is perhaps the notion that the royalty QualComm seeks is steep, that has now cornered UMB (with the Verizon/Vodafone LTE hint) or chased Motorola away for now.

Seth, I do agree with your point on the bad blood between QualComm and others. But, having been in some of these meeting myself, it is my opinion that the standards bodies serve as a platform for all companies to forward their interests. So blaming QualComm’s activities alone is not fair. But then, if the company wishes to succeed long-term, it should strive to change the way others perceive its business practices. I will take into account QualComm’s loss of Motorola (and the reasons) while I look into its future in the articles to come.

Thanks,
Vijay

Vijay Nagarajan Tuesday, September 25, 2007 at 11:18 PM PT

[…] QualComm: The Margins […]

The Law of Mobility » Blog Archive » Business Models: September 2007 Thursday, September 27, 2007 at 5:41 AM PT

[…] QualComm: The Margins […]

The Law of Mobility » Blog Archive » Business Models: September 2007 Thursday, September 27, 2007 at 5:41 AM PT

What you analysed is a very hypothetical scenario. But, the odds of that scenario becoming real are extremely small. The most likely scenario will be Qualcomm settling with Fraudcomm on some less than favorable terms. Also, Qualcomm coming up with a work around to that “not so important” power savings patent is not ruled out yet. In the worst case, Qualcomm can always spin off its licensing division into a seperate company, which will keep milking the industry for years. The remaining piece, qualcomm chip set division, could become a normal semi conductor company as you pointed out. Even in that break up scenario, Qualcomm shares could be easily worth north of 50$/share. I personally think, current qualcomm valuations are extremely attractive. Smart hedge fund managers like George soros and others have been loading up qualcomm shares in recent months.

Just to get some perspective, I would suggest you look at the history of research in motion. Two years back when it was involved in legal troubles, some people were talking about RIMM going bankrupt in worst case. Two years later stock became 3 fold and shorts got castrated. Even in Qualcomm case, that is going to happen. Just a matter of time. It is like a compressed spring waiting to rebound. Don’t buy this fool’s analysis.

flower Tuesday, October 9, 2007 at 7:10 PM PT

Flower,

Please do not call people names. Stick to data, logic and reason. I don’t tolerate unprofessional behavior on the site.

Sramana

Sramana Mitra Tuesday, October 9, 2007 at 7:25 PM PT

Flower,
Thanks for your comments. I think you have misunderstood the premise of this article all together. I have made points in the articles and in my comments (See above) that these are not necessarily royalty amounts that QCOM will pay BRCM for the ITC patent. All I wanted to point out was that if QCOM lost a bunch of cases (EC, ITC etc etc) [and the possibility is quite real, my friend], then it is likely to be hit in its IP profit margins. That is a fact. It does not have to pay $6 to BRCM, but a $1 here and a $2 there either in the form of royalty for chips it is selling or reduced royalty for its IP can make a difference. Don’t you agree? Hypothetical situation alright, but I would not agree that it is a low probability event. Also, any analysis is based on hypothesis and speculation. It is up to the reader to make a judgment call based on what he sees. And we will be happy to correct ourselves if there are new perspectives that our readers give us.

That being said, I also think that QCOM produces the best products in the mobile industry. The only point being argued is that the industry has a perception that the royalty rates are high and are polarizing to bring that down. Let us wait to see where the cases end.

Besides, I would advise you to read through the entire series and comments before you make statements. That ways, you will have a better picture of where I am headed in my analysis and what points you should really be making to help us if you don’t think we are on track.

Lastly, RIMM may be a good perspective. But what was true for RIMM need not be true for QCOM just given the mobile value chain and the company’s position as a chipset vendor. Of course, no one here is even suggesting that QCOM will go bankrupt. Thanks again. Please keep reading and give us your valuable insights and remarks. It can only make this debate better.

Vijay

Vijay Wednesday, October 10, 2007 at 9:23 AM PT