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From Argus research....About a month and a half old.
RECENT DEVELOPMENTS
Recent weakness in the stock reflects concern that Qualcomm is at risk of losing the first round in the heated patent battle with rival Broadcom. The slew of suits and countersuits between the two companies is confusing. (For more details on the litigation, please see are previous notes on the company, which are archived on the Argus Research website.)
BRCM has also come down sharply from its 52-week high of $50 (split-adjusted) - by about 26%. Lately, though, it has returned to its market-favorite status, on the early - and perhaps faulty - perception that it now holds the upper hand in the messy patent litigation with Qualcomm.
The first action to be heard in the patent dispute relates to a filing last year by Broadcom before the International Trade Commission (ITC) alleging that Qualcomm infringed Broadcom patents. The patents in question do not relate to the core code division multiple access (CDMA) wireless technology in which Qualcomm holds an unmatched IP position; nor do they relate to radio frequency (RF) transmission. Instead, the patents relate to ancillary features that Qualcomm has built into its comprehensive chip-set architecture, including multimedia features and applications processing. It is our understanding that Qualcomm acquired some of this expertise in niche acquisitions made in past years. Broadcom is a minor player in wireless basebands used in cellular phones, and has little presence in particular in 3G. But it is an industry leader in multimedia chips.
Typically in these matters, an administrative law judge (ALJ) assigned to a case conducts evidentiary hearings in which the parties and an ITC staff attorney submit briefs. The ALJ then issues an initial determination for review by the full international trade commission. The ITC then issues its own decision which may adopt, reject or amend the ALJ's decision. Any appeal of the ITC's decision is heard in the federal circuit court of appeals, the same appellate court that hears appeals of patent cases tried in U.S. district courts.
The ALJ assigned to the Broadcom-Qualcomm case divided the hearings into two phases. Before the first hearing, two of the five patents originally asserted by Broadcom were dismissed. The first hearing on the applicability of the patents and validity of Broadcom's claims concluded in March. No initial determination by the ALJ has been issued. The deadline for the ALJ's determination is August 21, 2006; at that point, the second hearing will likely be concluded. The second hearing is set for July 21, 2006. The ITC is expected to complete this process by December 21, 2006.
On May 16 and May 17, analysts first began to report that a staff attorney for the ITC had posted a brief on the company's website, setting forth this particular attorney's view following the first phase of the hearing. We have not seen this brief, but have obtained a summary of the staff attorney's findings. The staff attorney argues that Qualcomm products infringed parts of two of the three patents at issue. One patent (6,374,311) appears to relate to wireless network nodes communicating with one another while in a power-saving state. The second patent (6,714,983) appears to relate to transmissions between transceivers and receivers in different modes (wireless and wireline) and operating at different frequencies.
In this first round, several sell-side analysts appear to have prematurely conceded the early advantage to Broadcom. In our view, the staff attorney may not have had access to Qualcomm's own patent portfolio in these matters. We will withhold judgment on this matter until the ALJ rules; only the ALJ will have full exposure to the arguments of the two sides as well as the staff attorney.
Assuming a worst-case scenario for Qualcomm - that the ITC upholds the validity of these patents - the company would likely be compelled to pay a royalty for any application that uses the infringed patents. However, we believe any such payments would be immaterial, based on worst-case scenario guidance from Qualcomm, on the fact these applications are not central to Qualcomm's core competency, and on Qualcomm's immense cash flow generation (typically more than 50% of revenue in any quarter) and its cash hoard (topping $11 billion).
Qualcomm may also have some leverage in this matter, even assuming a favorable outcome for Broadcom. Qualcomm has also sued Broadcom for patent infringement. Qualcomm is most closely identified with spread spectrum technology, under the rubric CDMA; second-generation wireless technology, or GSM, is based on time division multiplexing, not code division multiplexing. Still, over the years, elements of Qualcomm's technology related to network efficiency and enhanced call volumes have migrated to GSM networks. Qualcomm's suit against Broadcom will commence in January 2007.
Strange as it sounds, this head-butting between two fabless semiconductor giants could actually culminate in licensing agreements between the two companies. Qualcomm's royalty and contractual arrangements with Texas Instruments and Nokia contain some technology sharing provisions; in particular, we think Qualcomm licenses some DSP technology from TI. These agreements have the effect of reducing the net royalty payments for all companies involved. Should each company win its particular patent case, the temptation to cut losses and negotiate will be overwhelming.
Broadcom investor relations head Peter Andrew has argued that Broadcom's patent infringement claims cover 90% of Qualcomm's products, while Qualcomm's claims cover just 10% of Broadcom's products. Mr. Andrew called the Broadcom-favorable web posting from the ITC's staff attorney a battle won in a long war; but he also noted that the ALJ's decision coincides with that of the staff attorney '80% to 90%' of the time. According to Mr. Andrew, Broadcom is not required to license the disputed technology to Qualcomm. Broadcom maintains that this technology is embedded in every Qualcomm baseband chip.
There is the possibility, then, that Qualcomm would have to introduce a new 'fix' for this particular technology. While we believe that such a fix would be disruptive but not disastrous, the company might also be liable for back royalties on past chips shipped, as well as penalties.
But acknowledging that Broadcom has less at risk in this litigation war is another way of saying that Broadcom has just a small presence in the semiconductor market for wireless devices. Its presence in 2G GSM is 'miniscule,' according to Mr. Andrew. The company is using its own technology in the 3G UMTS market and will butt heads in the courts with Qualcomm on this issue as well. Simply by producing 3G-compatible CDMA basebands, Broadcom must be infringing Qualcomm's patents. In other words, for all its bluff, if Broadcom can't come to a licensing arrangement with Qualcomm, it will inevitably be shut out of this market.
Some investors wonder why Broadcom is attempting to push into the 3G device semiconductor market, given its highly successful franchises in other parts of the communications world. Broadcom is the leading provider of Ethernet chips for Ethernet LAN applications (Cisco is a frequent 10%-plus customer); the leading provider of chips for set-top boxes and modems (Motorola is a perennial 10%-plus customer); and among the leaders in two very fast growing niches: Bluetooth connectivity chips and multimedia processors.
Broadcom has no choice but to enter the 3G wireless market, in our view, based on the future shape of the market. Cisco's fastest-growing niche in the enterprise market is not wired LANs, but rather wireless LANs. Set-top boxes, too, will likely dispense with in-house wires in the next few years. Mainly, coming network technologies such as IMS and WiMax argue for device fluency and interoperability between wired and wireless settings and between broad wireless coverage and hot-spot wireless coverage. Broadcom executives realize that to participate in the future network, the company must produce chips that work in devices that act as traditional wireless phones within broad network coverage, wireless data terminals within hot-spot coverage, and cordless phones in an in-home environment.
At Qualcomm's May 4 analyst day, CEO Paul Jacobs - remembering a pledge made a year earlier that fiscal 2006 would be a year of innovation, execution and partnering - joked that the fourth constant of the past year had been litigation. The Broadcom litigation issue was addressed; for the first time in our memory, Qualcomm's lead counsel sat in on every panel Q&A. However, analysts and investors were much more concerned about the recently released news that the royalty and licensing agreement between Qualcomm and Nokia was set to expire in April 2007.
In our view, Broadcom has too much to lose by not licensing 3G technology from Qualcomm. And it is in Qualcomm's interest to solve any patent disputes with Broadcom, Nokia and other major players. While this patent mess could get uglier in the short term, it may ultimately catalyze a productive relationship between Broadcom and Qualcomm. |
