Industry vs. Qualcomm - A call to arms
The opening salvos in what we expect to be a long and bitter struggle were fired today with Nokia, Ericsson, NEC, Panasonic and TI all filing complaints to the EU regarding Qualcomm's business practices in W-CDMA.
Main Points
* The complaint is based on the principle that all holders of IP must agree to when their IP is incorporated into a standard. In this principle is enshrined the notion that the IP in the standard must be licensed on "fair, reasonable and non discriminatory (FRAND) terms. This complaint alleges that Qualcomm has breached this principle in a number of ways.
* The complaint against Qualcomm is made on three levels. It alleges that
o Qualcomm's W-CDMA royalty rates are too high given that they are the same as for CDMA2000 but Qualcomm's technological contribution to W-CDMA is substantially less
o Qualcomm discriminates against non Qualcomm chipset customers by giving Qualcomm-exclusive chipset customers lower royalty rates than others.
o Qualcomm refuses to give potential chipset competitors fair and non discriminatory terms when licensing its essential W-CDMA IPR.
* The complaint also alleges that these practices will have harmful effects on the overall market for W-CDMA handsets by increasing the price that operators and consumers will have to pay for their handsets.
* These companies are asking the European Union to investigate and presumably take similar punitive action as it has done with Microsoft.
Nomura's view on these complaints
1) Qualcomm is harming the market for W-CDMA
* We find that referring to operators and consumers being disadvantaged in W-CDMA by Qualcomm's behaviour erroneous. Qualcomm's real competitor is GSM and EDGE where Qualcomm earns $0.
* Therefore it is in Qualcomm's interest to ensure that W-CDMA migrates as far down the market tiers as possible. Even at much lower royalty rates this would represent incremental income and therefore Qualcomm has no incentive to act in a manner that hinders uptake of W-CDMA.
* We believe that this substantially weakens the argument to the EU that Qualcomm is behaving in a manner that hurts consumers and limits the market for W-CDMA.
2) Qualcomm's royalties are excessive and disproportionate
* We believe that this complaint is at least partly based on the Nokia sponsored study by Goodman and Myers. This study found that while Qualcomm holds 48% of the essential patents in CDMA2000 it only holds 19% of the essential patents for W-CDMA.
* On this basis the complainants deem it unfair that Qualcomm should collect the same royalty on W-CDMA as in CDMA2000 as it contributes a substantially lower share of the technology.
* This argument is a very valid one but there are some weaknesses in the logic.
o We believe that some of the essential IPRs will be more important than others. For example an aeroplane must have seats but will still fly without them. The study also found that Qualcomm owns 54% of the IPR that is common to both W-CDMA and CDMA2000. Given that the two standards are very similar at heart implies that Qualcomm owns more of the truly essential IPR (engines ailerons etc...) than the study concludes.
o In the early days of GSM, royalty rates could sometimes amount to far more than 20%. Market share of shipments was much more aligned with ownership of IPR in GSM than in W-CDMA. This meant that IPR was really only an issue for smaller players with little or IPR due to cross licensing arrangements. We believe that this was a factor in keeping the Japanese makers effectively out of the market for GSM handsets. We believe this 'cosy' arrangement for GSM puts the argument for 'free and fair' W-CDMA licensing on a weaker footing.
* We believe that there is a case to answer as to why licences should effectively pay royalties to Qualcomm on GSM and other technologies where it has no IP but the case for a lower technological contribution to W-CDMA will be far harder to argue.
3) Qualcomm's gives lower royalty rates to customers who exclusively buy chips from Qualcomm
* We believe that this complaint has by far the most potential to damage Qualcomm.
* In China Qualcomm has given exclusive chipset customers lower royalty rates for shipments inside China. For shipments outside China the rate is higher to compensate for the discount.
* This is the only instance that we are aware of where chipset customers benefit from a lower royalty rate and clearly only applies in China.
* Qualcomm has repeatedly stressed that outside of this exceptional arrangement all licensees pay essentially the same rate with only negligible variation.
* We believe that the EU would take an extremely dim view of exclusive chipset customer shipments in Europe carrying materially lower rates than non chip customer shipments.
* Therefore we believe that if this complaint is upheld the EU will take material punitive action against Qualcomm resulting in a significant impact on licence revenues and profits.
* That being said, if Qualcomm's statements are true then it should be quite trivial to provide evidence refuting this claim resulting in no case to answer.
4) Qualcomm refuses to give fair licensing terms to other chipset vendors
* This complaint is based on the same complaint that Broadcom filed against Qualcomm on July 5th 2005.
* This complaint centres around Qualcomm's practice of demanding and receiving royalty free cross licensing for technology included in QCT chipsets.
* It alleges that the same unlawful and uncompetitive practices that were used to win the CDMA2000 market are being used to try and dominate the W-CDMA market.
* Regardless of the merit of this accusation, one thing stands out. Qualcomm is using the same types of business practices in W-CDMA as in CDMA2000.
* To date all cases against Qualcomm in CDMA2000 have been resolved out of court and we suspect in Qualcomm's favour.
* If the business practices are the same and to date Qualcomm has won all of the legal arguments then it stands to reason that the same arguments will prevail in W-CDMA.
* Furthermore given that current market share in W-CDMA is far lower than in CDMA, Arguments of monopolistic behaviour could prove much harder to uphold.
Take Home Message
* The only thing that can be said with any certainty is that this dispute will take a very long time to be resolved.
* Until it is resolved (years), the current status-quo is likely to persist where Qualcomm collects its 4-5% on the wholesale price of every W-CDMA handset that is shipped. Therefore we anticipate no change to Qualcomm's revenues or Nokia's costs in the medium term.
* We think that the complaint with the heaviest implications for Qualcomm is number 3. If the EU enforces punitive actions on Qualcomm we suspect the rest of world will quickly follow. The outcome of this complaint would be unlikely to be limited to just shipments in the EU and would have material implications for Qualcomm's business.
* We also believe there is a case to answer for compliant 2 but only where licensees are effectively paying royalties on non Qualcomm technology. We think that a practical solution to this dispute will be very difficult to achieve.
* This is the industry's first serious attempt to crack Qualcomm's hold over CDMA technologies. It is rattling the cage pretty hard but will have to do an awful lot more shaking to do if it wants the door to pop open.
* We reiterate our Buy rating on Nokia, Sell rating on Ericsson, Neutral rating on Qualcomm, Buy rating on Matsushita, Reduce rating on NEC and Buy rating on TI.
Republished with the kind permission of Dr Richard Windsor and Nomura International.
Dr Richard Windsor CFA
Communications Equipment
Nomura International
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No 1 St Martin's le Grand
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