On the Brink of Reaping Rewards, Qualcomm Faces Customer Uprising MARKETPLACE By Bloomberg

Oct 12, 10:09 AM

Current Headlines: By Ian King and Amy Thomson

Qualcomm earned more than $11 billion in royalties from its cellphone technologies this decade. Just as the company bet those payments would accelerate, some of its customers started to balk.

Nokia, the largest mobile phone maker in the world, is seeking to persuade a U.S. trade judge that its mobile phones do not use some of Qualcomm's patents. An initial decision is due next month. A loss could force Qualcomm to cut its fees at a time when its chip designs are taking over the industry.

At stake is a patent licensing business that provided 76 percent of Qualcomm's operating profit last year. The company may have to make concessions in the Nokia case, according to David Airan, a patent lawyer at the Chicago law firm of Leydig, Voit & Mayer. That could prompt other telephone makers to demand price cuts, eroding Qualcomm's position in the $39 billion market for cellphone chips.

"Qualcomm will not be able to take its royalty model further - that's absolutely clear," said Per Lindberg, a London-based analyst for Dresdner Bank who rates shares of the company, which is based in San Diego, "sell" and expects them to fall as much as 41 percent to $25. "This saga will become more and more embarrassing for Qualcomm."

Qualcomm, the second-largest maker of cellphone chips behind Texas Instruments, commands a high share price because of its success at charging others to use its technology.

The company has a market value equal to 8.2 times trailing 12- month sales, more than twice the average of companies in the Philadelphia semiconductor index, reflecting the high percentage of Qualcomm sales that turn into profit.

Qualcomm's price-to-earnings ratio fell to 21 in mid-August, the lowest ever, on concern royalty rates would come down. RCM Capital Management sold some of its Qualcomm holdings in June, said Walter Price, who helps oversee $120 billion in San Francisco. "Any risk to that royalty stream has implications about the valuation," Price said.

Paul Luckern, a judge at the U.S. International Trade Commission is scheduled to decide Nov. 13 whether three Qualcomm patents on its Code Division Multiple Access mobile phone technology are valid and apply to Nokia's new phones using Wideband-CDMA, a derivative of CDMA that is taking hold globally for phones that offer high-speed Internet access.

"There is a race to get the first ruling in your favor," said Lyle Vander Schaaf, a lawyer at Bryan Cave in Washington. "Those decisions have significance outside the U.S. market."

CDMA is used on Sprint Nextel and Verizon Wireless networks in the United States and in 18 percent of mobile phones shipped globally, said Will Strauss, an analyst at Forward Concepts in Tempe, Arizona. He estimates shipments of WCDMA cellphones would grow 60 percent to 150 million this year.

The fees Qualcomm gets on WCDMA phones are about 4.4 percent of sales, similar to the company's CDMA fees, said Cody Acree, an analyst at Stifel Nicolaus.

"Competitors, which haven't been able to beat us in the marketplace, have decided they are going to try the court system and trying to appeal to government regulators," the Qualcomm chief executive, Paul Jacobs, said. "The legal battles are going to go on for a while."

Because of the dispute, Qualcomm would not recognize royalty revenue from Nokia in the fourth quarter ended Sept. 30, reducing profit by 5 cents a share. Jacobs said discussions have not yielded progress and an outside force may be needed to forge a solution.

"Maybe this will be an impetus," Jacobs said of Luckern's forthcoming decision. "We have some flexibility, but we're not going to give up what we've worked so hard to achieve."

A Nokia spokeswoman, Laurie Armstrong, said the company, based in Espoo, Finland, was committed to negotiations.

"When it comes down to the facts,' ' she said, "we are confident in our position."

A settlement that reduces Qualcomm's royalty fees could lead other licensees, including Samsung Electronics, to ask for concessions.

"I don't really understand how Qualcomm can work out a deal without compromising their deals with other customers," said Bill Gorman, an analyst at PNC Institutional Investments in Philadelphia.

Qualcomm lost rulings in a separate patent dispute with Broadcom, temporarily averted a ban on imports of phones using its chips into the United States, and faces an antitrust investigation in Europe.

Jacobs shored up his legal team last month, hiring Donald Rosenberg as general counsel from Apple. Qualcomm "didn't have the process in place for this sort of large-scale multicompany attack," Jacobs said.

The shares would be worth almost $54 if the disputes did not exist, said James Faucette, an analyst at Pacific Crest Securities which is based in Portland, Oregon.

The share price would "pop" if Qualcomm gets a favorable ruling from Luckern, Daniel Morgan of Synovus Securities in Atlanta.

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Amy Thomson reported from New York.

Originally published by Bloomberg News.

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