Qualcomm’s patent licensing system is the root cause of much dispute. By targeting changes in it, Broadcom can win over antitrust regulators and Apple.
In a development pregnant with possibilities, a source familiar with the matter at hand has stated, Broadcom Ltd has hinted, as part of its $103 billion bid to acquire rival Qualcomm Inc, at the possibility of it making significant changes to Qualcomm’s patent licensing business, which is a major cash-cow but is also a source of bitter conflict with its key client Apple Inc as well as regulators.
Broadcom has provided very little details as to how it would go about bringing this dramatic changes.
So far, Qualcomm has squarely rejected Broadcom’s takeover bid saying, its offer price has undervalued the company and that the deal faces strong regulatory headwinds.
In fiscal year 2017, Qualcomm has reported $5.1 billion in pre-tax profits as coming from its patent licenses, this is nearly two and a half times more revenue than its $2.7 billion in pre-tax profits that it reported for the same period, last year.
With Broadcom’s CEO Hock Tan wanting to make significant changes to this model, it will have to very carefully pair the suggested changes with big cost cuts elsewhere; analysts see Qualcomm’s annual $5.5 billion research and development budget as a prime target.
As per a source, if Broadcom is successful in acquiring Qualcomm, it would have to maintain the economics of the licensing business by adjusting the pricing structure between the licensing and chip selling businesses. Further, it would also have to attempt to renegotiate contracts with major customers.
Broadcom is eager to appease to customers, such as Apple, whose support it will require to overcome antitrust hurdles.
While customers often look askance at consolidation among their suppliers, Broadcom has said it offers a possible solution to a conflict that has led to a regulatory crackdown, lawsuits with Apple and also has prompted others to cease paying licensing fees.
At the root of Qualcomm’s practice with Apple is its practice requiring mobile phone makers to pay a license fee on its intellectual property in addition to what they pay for its semiconductors.
Apple has labeled Qualcomm’s approach as “double dipping.” in its legal complaint..
Qualcomm has repeatedly rejected the notion that its patent practices are anticompetitive and maintains that its chip business and patent business are run separately.
Earlier in November, Broadcom had gone on the offensive when it said it believes regulators, around the world, will “welcome this deal as a solution to the double-dipping issue.”
Further, in an interview to Reuters earlier this month, Broadcom’s Tan stated, he believes his company “can be very constructive in resolving these issues and resetting relationships. We would not have embarked on this offer if we were not confident that our common key customers would not embrace it.”
According to analysts, in order to resolve Qualcomm’s licensing issues, Broadcom has three options in front of it: it can either spin-off or sell it, charge more for its chips using its patents as leverage or shift to a model that charges a flat rate as its fees.
While the simplest option of spinning off Qualcomm’s licensing division is alluring, its valuation would be hard to gauge. Revenues from this unit has declined from $7.9 billion in 2015 to $6.4 billion in Qualcomm’s fiscal 2017 due to Apple and other customers suspending their dues.
However, if Qualcomm’s licensing unit is not sold, it could be pursuaded to do away with its unpopular practice by charging a flat fee per device, said Karl Ackerman, an analyst with Cowen and Co, in a research note.
According to Stacy Rasgon, the path of least resistance is likely to be ending the practice of asking chip customers to pay licensing fees and instead charge them a little more for the chips themselves. Further, Broadcom could sign long-term supply agreements using Qualcomm’s patent portfolio as leverage.
Such a move could lower the overall prices for Qualcomm’s customers, including Apple.
“It’s a completely different model of how to run Qualcomm,” said Rasgon. “(Broadcom’s CEO Tan) is essentially saying, ‘You guys are wrong – the licensing revenue is never coming back’”.
Although Apple declined to comment, it has indicated that it is willing to settle its patent disputes for a reasonable price.
Earlier this year, Apple settled with Nokia Oyj and handed over a $2 billion upfront cash with undisclosed ongoing payments spread across several years.
Either way, Qualcomm will lose around $2.5 billion per year in royalty fees, from Apple alone, estimates Rasgon.