Apple’s legal assaults on Qualcomm part of phone margin grab

Bloomberg

Apple Inc. is piling onto lawsuits that attack the way Qualcomm Inc. licenses technology for mobile phones in a widespread effort to rake back profits in a slowing market.
The latest suit by Apple alleges that Qualcomm has unfairly used the power of its patents, which cover the fundamentals of phone systems, and its chip business to prop up its dominant position in the industry. Apple’s legal actions follow regulatory investigations and fines on three continents, including a lawsuit announced last week by the US Federal Trade Commission.
“It feels like another coordinated attack on Qualcomm,” said Mike Walkley, an analyst at Canaccord Genuity. The mobile phone business is “a mature industry, they’ve got to get their margins higher.” Underpinning the government actions is a drive to shake loose Qualcomm’s grip on the smartphone business. In its last five fiscal years, Qualcomm has turned $37 billion of licensing revenue into $32 billion of
pretax profit. Its gross margin, or the percentage of revenue remaining after deducting the cost of production, is
61 percent and is predicted by analysts to widen.
Contrast that with Apple’s gross margin of 39 percent in its most recent fiscal year, a number that’s predicted to narrow in 2017. Samsung Electronics Co., the biggest maker of mobile phones ahead of Apple, also had a margin of 39 percent in its most recent fiscal year.
Apple, Samsung and LG Electronics Inc. are part of an increasingly competitive smartphone market in the midst of slowing growth.
Handset shipments likely increased 0.6 percent to 1.45 billion units in 2016, according to researcher IDC. As recently as the second quarter of 2015, the market was growing in double-digit percentages.
Samsung and LG are based in South Korea, where antitrust regulators announced in December a record 1.03 trillion won ($880 million) fine against Qualcomm for violating antitrust laws and called for the chipmaker to change its business practices.
In China, the biggest mobile phone market, antitrust regulators accused Qualcomm of abusing its dominant position. Rather than risk being locked out, Qualcomm in February 2015 paid $975 million to settle the case and was given the right to charge handset makers licensing fees, at a lower rate, for phones sold in the country.

LICENSING REVENUE
Apple on Friday added its weight to the growing call for a change in the way licensing revenue is calculated. Now, the handset companies pay Qualcomm a percentage of the total selling price of the phone — a sum measured in hundreds of dollars — regardless of whether they use Qualcomm chips or not. The phone makers, backed by regulators, want a change that would force Qualcomm to charge the fees on the price of its components — an amount based in the tens of dollars.
Qualcomm said Apple has been “actively encouraging” the government actions by “misrepresenting facts and withholding information” from regulators. “We welcome the opportunity to have these meritless claims heard in court where we will be entitled to full discovery of Apple’s practices,” Don Rosenberg, Qualcomm’s general counsel, said in a statement.
For Apple investors, any means necessary to bring down the iPhone maker’s costs is the right move. “Strategically if your enemy is somewhat wounded it’s not terribly surprising that they’d be that much more aggressive,” said Erick Maronak, chief investment officer at Victory Capital Management in Brooklyn, Ohio, which holds Apple stock among its $55 billion under management. “Any time they can reduce costs, whether it be legally, operationally or through new technologies, they’ve always been happy to pursue those.”