We are short shares of Qualcomm Incorporated. Please click here to read full disclosures.
We are short shares of Qualcomm Incorporated, a semiconductor company teetering on the brink of disaster. For years, Qualcomm has presented itself as a technological innovator that monetizes its R&D in two ways: 1) selling chips that go into smartphones and other wireless devices and 2) licensing its patent portfolio. The licensing business, despite contributing far less revenue than the chip business, has historically supplied roughly two thirds of Qualcomm’s profits, thanks to its extremely high profit margins.
This unusual business model is living on borrowed time. In the past few years, regulators across the globe have concluded that Qualcomm’s ability to extract massive licensing fees from device-makers like Apple and Samsung stems not from the quality of its patents but from unlawful monopolistic tactics. In particular, authorities in China, Taiwan, Japan, South Korea, Europe, and the United States have found fault with what they see as Qualcomm’s exploitation of its dominance in the market for premium modem chips (the components of smartphones that enable them to connect to cellular networks) to force device-makers to pay outrageously high patent royalties, even on devices that don’t contain Qualcomm chips, all while refusing to license its IP to potential competitors. These core Qualcomm business practices, regulators contend, violate binding pledges the company has made to license critical patents on “fair, reasonable, and non-discriminatory” (FRAND) terms, including to rivals like Intel. Indeed, in the words of the United States Federal Trade Commission (FTC), quoting an internal Qualcomm assessment from 2015, “granting a FRAND license to Intel ‘would destroy the whole current QTL [licensing] business.’”
If Qualcomm is right about that, then destruction is imminent. The FTC has brought a powerful legal case against the company, and the trial (conducted entirely before a judge, not a jury) is currently underway, with a scheduled end date of January 29th. We believe Qualcomm will lose, a view that we regard as the emerging consensus among informed observers, who have noted not just the strong evidence marshaled by the FTC but also the many instances before and during the trial when the judge signaled disagreement with Qualcomm’s legal views and even irritation with its lawyers.
Perhaps because prior legal troubles have “merely” cost Qualcomm billions of dollars without fundamentally transforming its business model, the market has failed to appreciate the potentially dire consequences of the current trial. If the judge grants the FTC the remedies it seeks, forcing Qualcomm, among other things, to license core patents to competitors and to renegotiate all of its existing licenses on fair terms, it could realistically cut Qualcomm’s licensing revenue, earnings power, and stock price in half. As Qualcomm’s long-running game of monopoly draws to a close, there will be no “Get Out of Jail Free” card.