NOMURA MORE. Nomura issued a second report entitled Equipment Matters: IPR Master, which is tied to the other report.
Nomura concludes that it will be very difficult to definitively show that Qualcomm has abused the FRAND principles. The one exception is bundling, where Qualcomm’s licensing program follows a one-price-for-everything system. Nomura believes that bundling will be found to violate FRAND principles, in that free and unfettered access to essential IPR must be provided to all licensees.
Sees it possible for Qualcomm to switch to licensing its portfolio in two pieces. This would eliminate the FRAND problem, as well as free it to pursue a market rate for its implementation IPR.
While all the fuss surrounds essential IPR, implementation IPR makes up >90% of most patent portfolios and is where the hard core litigation occurs. Becaise Qualcomm routinely brings technology to market far in advance of its competitors, Nomura believes that Wcom has the opportunity to patent the simplest and best methods for commercialisation before anyone else.
Arbitration is likely to result in a ‘no score’ draw. We think the claims of both Nokia and Qualcomm have little merit and that neither will be successful. Consequently, we think that at the end of this year we will be exactly where we are now. We see a range of infringement lawsuits on WCDMA implementation coming in early 2009 with a potential resolution in late 2009 or 2010. [There is no arbitration]
Rule of law will win the day. Wrongs are not righted in the world of IPR. Victory is most likely to be won by the company that is the best prepared with the sharpest counsel. Our analysis shows that none of the much-vaunted patent valuation methods will last five minutes under cross-examination, rendering them useless for supporting either case. Threefore, Nomura believes that in the next 24 months, one party will score a victory great enough to force the other side to the negotiating table.
The world of intellectual property is not one where wrongs are righted. It is one where whoever performs on the day, and is best prepared, ends up the eventual winner. Broadcom vs. Qualcomm is a perfect example, where bad management and poor preparation cost Qualcomm dearly. In this environment, the rights and wrongs of who has the most essential IPR are not as important as ensuring that the legal arguments are won. Consequently, we think that the mess that Qualcomm has made against Broadcom will serve it well in the much more important fight against Nokia. Its legal team has been rebuilt from the ground up with new management and its retained attorneys are on a much tighter leash. This, combined with strong essential and implementation IPR is what leads us to believe that, one
way or another, it will prevail. However, it’s probably going to be a long time in coming and we see no resolution before 2010... We think Qualcomm’s supremacy in the implementation of radio technology into silicon could end up being a decisive factor in the resolution of this dispute.
In a prior report a year ago, Nomura examined the relative strength of Nokia and Qualcomm by looking at the evaluation methods favoured by each company. Both of their methods remain deeply flawed, neither offers a clear picture of the real situation.
Given the fact that Nokia has already fully paid up for access to a number of the early patents, means that the dispute between Nokia and Qualcomm will likely be predominantly fought over the newer intellectual property. This pertains to HSDPA, HSUPA and HSPA+ rather than to plain vanilla WCDMA. one thing remains clear, CDMAone (2G) was developed before either of the other two. CDMAone contains the core fundamentals that make CDMA work and, because it was Qualcomm that got it working in mobility, it was Qualcomm that filed the essential IPR for CDMA. These fundamentals are not really in dispute, as it is these fundamentals that we think Nokia now has fully paid up access to.
The burning issue is whether Qualcomm’s contribution to the IPR behind 3G radio systems is limited to these innovations or whether it has continued to make seminal contributions to the 3G. The evidence is contradictory, but what is clear is that Qualcomm has consistently brought technology to the market one to two years ahead of its nearest rivals. This strongly implies that Qualcomm is far better at solving the myriad of problems involved with commercialising the standards. This leads to the conclusion that Qualcomm could easily have an exceptionally strong position in the IPR that is involved with how one gets the technology to work.
We are aware of 15 areas of commonality in WCDMA, 12 areas of commonality in HSDPA and five in HSUPA. We have no evidence of any commonalities between RevB and HSPA+ but we would not be urprised to find at least one or two.
Conclusions:
1. That the WCDMA (UMTS) standard has much more in it than CDMA2000.
2. That the radio functionality of UMTS is more complex than CDMA2000, due to the requirement for voice and data in the same channel.
3. Any company that confines itself to one part of a standard (such as Qualcomm in radio), is likely to find that its relative contribution to the UMTS standard is less than
in CDMA2000.
This would be the case even if its value contribution to radio is the same in both standards. That being said, we think that the standards are increasingly diverging and that the IPR in CDMA is becoming less relevant to WCDMA. This is negative for Qualcomm. From this conclusion, it is easy to make the very valid argument that the royalty rate payable to such a company should be less in UMTS than it is on CDMA2000. Furthermore,
taking into account the fact that there is some divergence between the two standards leads us to conclude that Qualcomm’s overall contribution to WCDMA is less than it is in CDMA2000. However, how much less, and what that contribution is worth in terms of royalties, is a question that is likely to be answered only by a court of law.
Imputed royalty rate for the CDMA industry is somewhere around
9% (cost of someone with no IPR to licence everything at the Qualcomm rate). In WCDMA, there are no reliable estimates for Qualcomm’s value contribution to the standard. Consequently, estimates vary from 32% to 11%, so that the implied royalty rate for the industry is from 14% to 40%, (which is clearly unsustainably high).
Both the patent counting and the non-self citation methods of measuring IPR are flawed. Patent counting is favored by NoK because it puts it in best light. Weakness is that the patents get a cursory examination, and Nomura believes that the increase in the number of patent applications filed in the last few years are more a matter of risk management and there is no assessment of the quality of the patents in getting the standard to actually work in the real world.
Nomura's 2007 update of the patent counting with later patents shows Qcom's percentage falls to 11%, a drop of another 7%. Taking the original 31% (declared essential IPR) we would calculate a not unreasonable rate of 14.2% for the industry to a very unreasonable 40% (using the 2007 findings). In contrast, for Nokia (assuming a 2% rate) we would calculate an industry rate of 14.4% based on declared essential IPR, and a 6.6% rate based on judged essential IPR. Based on these assumptions, it is not difficult at all to argue that Nokia has met its FRAND obligations and that Qualcomm has not. However that is only half the story. The problem with the above analysis is that it values every patent equally. Second, Qcom charges differently from anyone else by its one-price-for-all bundling of essential and implementation IPR.
In the study on which NOK relies, approx 33% of the patents declared essential by major developers were deemed essential for the UMTS s+tandard. But, in Qcom's case, only 11% were deemed essential. This doesn't make sense to NOmura. Furthermore, when Nomura updated with subsequent patents, only 6% of Qcom's patents were declared essential as opposed to 56% of Nokia's [smell a rat, this indicates that the SSO is being dominated by Nokia for its own advantage in my opinion], 38% for Ericy and 30% for InterDigital.
Only two explanations for the very poor performance of Qcom’s patents when assessed by the patent acctg method. (We are reasonably comfortable that the assessors of the patents were not biased in their judgment of essentiality). First, it is possible that Qualcomm has not concentrated its R&D on the development of the standards themselves. The reasoning behind this lies in QCT’s mission, which is to get the best chips to market faster than the competition. QCT does almost all (90%) of Qualcomm’s R&D, meaning that almost all of the technology sitting behind the patents has been created in QCT. Given its ission, Time adjustment and the fact that it has been very uccessful, we can easily conclude that the R&D focus has been n getting the technology to work in silicon rather than eveloping the standard. This would imply that the focus of the &D has been much more focused on implementation rather than ssentiality. Given this bent, it is easy to conclude that the atent claims were written with implementation in mind, paving he way for them to fall foul of the “essentiality” assessors. The second possibility is far more sinister. Rightly or wrongly, Qualcomm is not popular in the mobile industry and therefore has a reputation for standards abuse. Standards setting organisations are tasked with selecting the best technology to include in a standard, but bad feeling with regards to Qcom has been running high for some time. It is not difficult to believe that Qualcomm’s contributions have been deliberately excluded (even though they may well be superior) in order to minimise its ability to extract royalties from equipment using the standard. In this scenario it is very easy to understand why so much of Qualcomm’s technology is deemed ot be essential by the assessors.
A third reason is Qualcomm really only addresses certain parts of the WCDMA standard, which have been growing slower. Qcom's IPR falls in 4 categories: Source Coding, Handover, Radio Signals and Radio Resources, which in 2005 made up 54% of all judged essential IPR. In the new study this amount falls substantially to 37%, implying that most of the development of the standard has been concentrated in areas other than those in which Qualcomm excels.Plus, core radio is a much smaller part of WCDMA than of CDMA2000 and is likely to continue shrinking, thereby diluting its relevance when looking at measures which simply ascribe value on a patent counting basis.
This bias towards implementation does not make Qualcomm’s technology any less important, but it does mean that there is greater scope for it to be designed around. By definition, implementation IPR describes ways of doing things rather than the things themselves and it is here that Qualcomm’s real patent strength may lie. The problem is that there is a substantial push back on the one-price-for-all-the-patents model, which we think may end up having to be changed. We see this as perilous for Qualcomm’s antagonists as it could result in patent by patent assertions and a higher overall royalty bill. Single patents often command royalty rates of 1% or more meaning that only 3/6500 patents are needed to return close to the original rate.
In analyzing the non-self citation method, Qcom originally had a big lead over Nokia, but because Nokia has paid up licenses, the question arises what has happened since the date called for in the contract, which is unknown. Nomura assumed cutoff dates of 1997 and 1999. In 1996, Qcom had 62 non self citations but with a 1999 cutoff it had 40; by contrast Nokia went from 9 to 5, Ericy ends up with 14 and MOT with 17 under a 1999 cutoff scenario. Despite the drop in numbers, Qualcomm still leads substantially over Nokia, Ericsson and Motorola, implying that Qcom has made seminal contributions to the standardisation of the later releases of WCDMA. Nomura thus believes that Nokia is going to have a very difficult time in making the argument that Qualcomm’s contribution to essential IPR does not extend beyond the original CDMA patents for which Nokia has no obligation to pay royalties. One weakness of this method of valuation is that it does not address the claims under a patent.
Nomura believes that in litigation the weaknesses of each method will be exploited by the opposition and they will have little or no value to the fact finder.
Regarding Implementation IPR, there is no real way to value it. It's really a function of getting to market faster. Once again, Qualcomm is at one end of the spectrum and the mobile industry at the other. Handset makers tend to use implementation IPR defensively; they refuse to license in order to raise barriers to entry. In contrast, Qualcomm licences all of its IPR openly to anyone who wants it. In the vast majority of cases, paying for the IPR works out to be much cheaper than developing all of the technology in house, this explains why Qualcomm is so popular with handset makers who have little or no IPR (Asian vendors), and may also have been a significant factor in Motorola’s original decision to use Qualcomm WCDMA chipsets.
The only useful indication of value is the ability to implement IPR is time to market. The faster a company can bring technology to market is a rough indicator of how good that company is at implementing the technology in a commercial product. It is also an indication of who will have been able to file the earliest IPR for the easiest, and best, way of implementing the technology, which is also the most likely to be infringed by those who follow. This is particularly the case as implementation engineers tend not to pay much attention to potential infringement and focus merely on the best way of doing something. The problem with this analysis is that the only real comparison we can make is between Qualcomm and Ericsson. This is because the other players do not have such a well defined technology roadmap, or have not made it public (e.g. Nokia).
Nomura thinks it will be very difficult to prove that Qualcomm is in breach of its FRAND principles. The only area where Nomura sees a big problem is in the area of bundling. Qualcomm charges a single rate for its IPR, where one price covers
everything including the implementation IPR. The question is, how much of the 4.4% applies to the essential IPR and how much applies to the implementation, as this makes an enormous difference to Qualcomm’s adherence to the other FRAND principles.
If one assumes that all of the price is applies to the essential IPR and that the implementation IPR is free, then using patent counting results in an unreasonable 40% rate for Qualcomm’s IPR. However, if the real value of the Qualcomm portfolio is in the implementation IPR, meaning that this scenario of ‘pay for the essentials and get implementation for free’ would seem unlikely.
The counter argument is to use patent counting principles that patents are all of equal validity. That ascribes 0.44% (10% of the portfolio for the essential patents and 3.96% for the implementation patents). Nomura then calculates an aggregate rate of 4% for the essential WCDMA IPR, which is well within the scope of FRAND. Even if we assume the essential IPR is twice as valuable as the implementation IPR, then we would still end up with a very reasonable aggregate rate, assuming that Qualcomm’s contribution remains at only 11%. Nomura believes that this analysis throws enough uncertainty into the mix to render any prosecution based on unreasonable pricing
way beyond the realm of reasonable doubt.
Because FRAND requires free and unfettered access to standard essential IPR, it is an easy argument that Qualcomm’s current licensing program does not provide that as there is one price that covers all of the patents and currently no option to licence the essential IPR separately. On the surface this looks like a clear breach of FRAND principles but the situation is not that transparent. Qualcomm maintains that it is willing to licence just the essential IPR (presumably at a lower rate) but no-one has actually asked for a license that prices the IPR in two separate pieces. If true, then this would appear to be an adequate defence, but it raises the question: Why has Nokia not asked for an essentials-only patent licence?
In its arbitration filings Nokia mentions on numerous occasions its willingness to licence Qualcomm’s essential patents at FRAND rates. This immediately makes us wonder why the parties have not been able to come to terms, and we suspect that the answer lies in the implementation IPR. Although Nokia would seem to prefer to take an essential-only licence, we think it fears the contents of the implementation portfolio. Its biggest problem is that, by its own admission, it has no idea what parts of the implementation portfolio it has infringed because nothing has been asserted against it.[this may explain the contorted FRAND process in the Delaware pleading; however, essential patents are what the SSO declared to be essential--everything else is non-essential]
We see real risk in pursuing an essential-only licence, as it leaves Nokia open to the implementation portfolio. We have argued that Qualcomm’s time to market advantage, and focus on implementation through QCT, is a strong indicator that its portfolio in this area is very strong. Nokia has been licensed for the entire WCDMA portfolio since 2001, meaning that it would have been no need to monitor Qualcomm implementation patents and ensure that they had not been infringed during the development of WCDMA, HSDPA etc.
Consequently, we think it highly likely that Nokia has unknowingly infringed a number of Qualcomm’s implementation patents. Implementation patents are not covered by FRAND meaning that this strategy would leave Nokia open to the potential of substantial royalty stacking if infringement was found on a number of patents. If we assume that a fair price for its essential IPR is around 1% then it would only need 3-4 patents to be infringed to return the rate back to 4.4% or so. If the Broadcom example is to be followed then only one would be needed. As these are implementation patents, the possibility for a design around would always exist, but we suspect that some are so fundamental that a work-around would be time consuming and expensive. Furthermore, as Nokia has no idea what it may or may not have infringed, it is very unlikely that any work to shorten development time has been
possible.
We see a scenario where Qualcomm offers to split its portfolio in two as increasingly likely, as it solves its most pressing issue with FRAND and allows a market rate to be earned for the implementation portfolio. We see a change in the licensing system not dissimilar to what happened to Symbian in 2005, where licensees went from one system to being able to choose from three options. We think it highly likely that an out-of-court settlement between Nokia and Qualcomm could involve Nokia taking a licence for the essential IPR at a much reduced rate and then taking a separate licence for the implementation.
Arriving at a resolution will not be easy, as we suspect that Nokia does not believe that it needs a licence for the implementation IPR. In fact, we think that it will probably push for a cross licence as Qualcomm indubitably infringes on Nokia IPR in all of its chipsets. Nokia’s IPR position is stronger now than it was in 1992 or in 2001 and so it is right to explore this revenue opportunity. We think that the parties are now so far apart that it will take a lot of legal wrangling before there is movement on either side.
We think that each side is basically utilising the same legal strategy, which is to launch a raft of legal manoeuvres that are peripheral to the main issue at stake in the hope that a
lucky win will force the other party to the table. This is particularly likely because it is in the best interests of both parties if the contract that exists between them remains in force. The current contract basically prevents either party from launching infringement lawsuits over WCDMA as there are clauses in the contract that prohibit the assertion of previously licensed IPR. This is why Qualcomm has been limited to prosecuting GSM-only IPR and why Nokia has only launched cases based on licensing practices such as patent exhaustion. The effect of a lucky hit can be substantial as the wins that Broadcom registered against Qualcomm during 2007 show.
We think that most of these “legal long-shots” have very little merit, and are merely being prosecuted on the off chance that a win would substantially improve one party’s negotiating position when it comes to an out-of-court settlement. To date the long-shots on both sides of the fence have not yielded any results, which leaves us with the prospect of the arbitration between the two companies as the next big event.
The arbitration now consists of two elements: 1) Qualcomm’s contention that Nokia has effectively exercised the option to extend the agreement until 2013 or 2022 by continuing to ship infringing product and 2) Nokia’s contention that Qualcomm has breached its FRAND commitments with respect to the licensing of essential IPR. In summary, we think that the outcome will be a no score draw. As discussed on page 17-18, we think it will be very difficult for Nokia to prove that Qualcomm has breached its FRAND commitments beyond bundling, and very unlikely that the court will decide that the Nokia has effectively exercised the option. We think that this will leave investors pretty much exactly where they are now. We think that going into calendar 2009, Nokia’s fully paid up licence to Qualcomm’s early patents will remain in force and the options will have expired unexercised. We think that this will leave the way open for Qualcomm to launch an assault upon Nokia’s use of its IPR in WCDMA, which we have long believed will be the decisive battle. We think that this will focus on implementation IPR, as this would prevent Nokia from using the standards abuse defence, but infringement will be harder to prove and will also allow Nokia to create a work-around. If the
implementation patents asserted are fundamental and numerous in quantity, then there is a good chance that it will make more sense for Nokia to take a global licence of all IPR both
essential and implementation. We think that there is a good chance that a new contract will involve separate terms and licensing for essential and implementation IPR. We think that the strength and size of the implementation portfolio will mean that the overall rate will end up pretty much where it would have been under the original agreement. This is likely to be more palatable to Nokia as it will always have the option to innovate out of the implementation piece, but we think it likely that it will remain impractical to do so.
The issue that needs to be resolved is the licence that Qualcomm needs for Nokia’s IPR.
We do not dispute that Nokia’s position in WCDMA IPR has become very strong over the last five years. We think that a good portion of its 11,000 patent families are related to WCDMA and that Qualcomm needs to access at least the essential IPR for the implementation of both CDMA2000 and WCDMA. The question is, how much will Qualcomm have to pay for this licence to include Nokia technology in its chipsets? We suspect that the answer is nothing. There are two reasons for this. First, we are virtually certain that in the last contract Qualcomm paid nothing to cross-licence Nokia technology to customers. Second, by Nokia’s own standards, Qualcomm paying money to Nokia to put its essential IPR into its chipsets would exhaust the patents. This would mean that handsets containing Qualcomm chipsets, upon which royalties had been paid to Nokia, would no longer be subject to royalty demands from Nokia for the essential IPR. Royalties on handsets, even at a FRAND rate, will be many orders of magnitude greater than the royalties on the chipsets, and so it makes much more sense to chase the handset maker for the
royalty and not the chipmaker.
Furthermore, Nokia has unsuccessfully prosecuted two cases (one in Holland and one in Germany) citing patent exhaustion on Qualcomm patents due to the cross-license that Qualcomm has with Texas Instruments. In an instance where Qualcomm is paying royalties to Nokia for its IPR, any handset maker wishing to avoid paying further royalties to Nokia need only bring-up these two complaints to give Nokia a very hard time. Consequently we believe that it is in Nokia’s interest to grant Qualcomm a royalty free cross-licence (as almost everyone else does). Consequently we think that Nokia’s arguments regarding Qualcomm’s need for licence, while true, will have very little bearing on resolution of the dispute.
Conclusion
Whatever the outcome is, it is going to be some time in coming. We expect that the arbitration will result in a ‘no score’ draw towards the end of this calendar year. This would
mean patent assertion and lawsuits could be filed in the first half of 2009 with the cases being heard in Q3 09 and potential resolution at the end of 2009 or early 2010. This assumes that one side suffers a defeat somewhere along the line and is forced back to the negotiating table. If not, then resolution could me much longer in coming as one would have to endure almost endless appeals and re-appeals before any court imposed resolution was enforced. RIM was found in wilful infringement of NTP patents in 2002 but it was not until 2006 that RIM actually paid-up.
The problem with predicting the outcome is that it is not necessarily the company that is in the right that will win. It is the company with the best prepared case that is the most convincing in the day that is likely to prevail. That being said, this kind of analysis is helpful as it gives us an indication of who is in the best position to put together a winning case and it helps us to outline a scenario for resolution.
In terms of valuation, things have changed meaningfully from the last note, mainly due to the substantial rally in Nokia’s share price. During 2007, market share gains were reported hand-in-hand with a return to very high margins (low to mid 20’s). We believe that this was aided by ceasing to pay royalties to Qualcomm at the previous rate. Instead, quarterly payments of US$20m have been made which we think is the sum of all of the charges put through the profit and loss account. Consequently, Nokia’s margins are implicitly forecasting that Nokia is successful in achieving a lower rate from Qualcomm. Therefore, we have looked at three scenarios. 1) Where Nokia never pays Qualcomm again for use of any of its IPR. 2) Where Nokia pays a reduced rate of 1% reflecting licensing of the essential patents only and 3) Where Nokia ends up paying royalties for both implementation and essential IPR with an aggregate rate of 4.4%. We have only used DCF in this analysis as the outcome is likely to be so long in coming that the relative based, short-term measures are not meaningful in this analysis
DCF based valuation of Qualcomm and Nokia based on different outcomes
Scenario DCF DCF
Qualcomm
($)
Difference to current
price
Nokia (€) Difference to current
price
Nokia never pays again 55 30% 29 35%
Nokia pays essentials only at
1%
59 40% 28 30%
Nokia pays both at total of
4.4%
70 66% 25 16%
One year ago, the situation was clear, Nokia was pricing in paying 4.4% and Qualcomm was pricing in losing all of its royalties from Nokia. Qcom’s situation has not changed, but the fact that Nokia has only been booking tiny royalties for a few quarters has moved expectations up. Forecasts now implicitly include a much lower royalty rate payable to Qcom for the foreseeable future implying downside when the dispute is finally resolved. However, the recent sell off has pushed the shares significantly below the implied valuation in any of scenarios underpinning our positive stance on the shares regardless of the eventual outcome with Qualcomm.
However, long-term investors should note that unless they believe that Nokia will never have to pay Qualcomm again, Qualcomm’s shares offer significantly more upside in either scenario. This is a major reason for our positive view on the investment outlook for Qualcomm which we have today also initiated coverage with a BUY rating.
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nok wants to pay small royalty for essential and then litigate the non-essential. qcom will then have to monitor every handset at exhorbitant cost, plus the cost of litigation all over the world. NOK again playing its international strength. But, if Qcom can find 1-3 nonessential patents that are being infringed, then it's Katy Bar the Door. Nokia is looking out for itself but screwing the rest of the industry, but then what does it care. It figures it can manipulate the system and get away with it. |
