Qualcomm cuts Nokia a deal

Qualcomm and Nokia were due to go to trial Wednesday on their longstanding dispute of how much Nokia will pay Qualcomm for CDMA (mostly W-CDMA) patent royalties. The dispute began in April 2007 when their 2001 patent license agreement expired: Nokia stopped paying royalties, Qualcomm filed for binding arbitration, the two sides started negotiation, and when that failed they prepare for trial. While Nokia’s previous royalty rate was not disclosed, Qualcomm’s standard royalty rate is normally estimated at 4-5% of product cost.

Last night I heard on the radio that Nokia and Qualcomm had settled their dispute. Sure enough, last night (early Thursday in Espoo) they issued a joint press release:

Nokia and Qualcomm today announced that they have entered into a new agreement covering various standards including GSM, EDGE, CDMA, WCDMA, HSDPA, OFDM, WiMAX, LTE and other technologies. The agreement will result in settlement of all litigation between the companies, including the withdrawal by Nokia of its complaint to the European Commission.

Under the terms of the new 15-year agreement, Nokia has been granted a license under all Qualcomm's patents for use in Nokia mobile devices and Nokia Siemens Networks infrastructure equipment. Further, Nokia has agreed not to use any of its patents directly against Qualcomm, enabling Qualcomm to integrate Nokia's technology into Qualcomm's chipsets. The financial structure of the settlement includes an up-front payment and on-going royalties payable to Qualcomm. Nokia has agreed to assign ownership of a number of patents to Qualcomm, including patents declared as essential to WCDMA, GSM and OFDMA. The specific terms are confidential.

The timing of the settlement was forced by both the trial (which was scheduled to be webcast) and Qualcomm’s scheduled Q3 earnings release and conference call.

I’ve been looking for something — anything — that provided specifics on the deal, but there was almost nothing. The earnings call was rescheduled to 5am PDT today (not that I would have gone), but neither the WSJ nor Seeking Alpha has posted a transcript. Thus, I’ve attempted to make my own estimates of the numbers.

The WSJ quoted a Lehman analyst as saying that Nokia would have paid $600 million in royalties in 2008 under the old deal. The 2007 royalties were estimated at $400-500 million (alternately, $250-400 million net after). At one point, Nokia offered 20% of their prior royalty rate, part of their goal to cap total WCDMA handset royalties at $5/unit.

Translating from euros, Nokia sold $36.6 billion in mobile devices in calendar year 2007. Due to plummeting handset prices, handset revenue growth in 2007 was only 1.3%, but sales of 437 million units meant unit growth of 26%.

I only saw two pieces of hard information: QCOM CFO William Keitel said (in his slides) that the settlement would be worth 7-13¢/share in FY 2008 (ending Sept 28) and 20-28¢/share in FY 2009. Based on 1.62 billion shares outstanding, that’s $113-211 million (net after) this year and $324-454 million next year.

Since there’s an “up front” payment — plus all the missing royalties from Q3 and Q4 of 2007 — it’s not clear why the 2007 payment is lower than the 2008 payment. The only two explanations I can think of are a) payments have been deferred past Sept. 30 or b) the value of the patents assigned are large enough to materially reduce payments. (Keitel said some of the improved net income was due to reduced legal costs, but my guess is that the savings are no more than $50m/year pretax out of an an annual legal bill of $200m/year).

While Nokia’s payments translate to revenues for Qualcomm Technology Licensing, and presumably to pretax income. After tax income is going to be less: the average (not marginal) tax rate for 9 months of FY2007 was 19.4%, while the marginal tax rate for California corporations is 43.84%(35% fed + 8.84% state). The 2007 10-K (with a 26% marginal tax rate) makes it clear that the marginal tax rate is mainly lower due to foreign earnings tax treatment. (I would expect payments from Finland would thus have a tax rate lower than 26%).

At a 26% marginal tax rate, then Keitel’s numbers would translate to payments of $438-614 million in FY2008. Those numbers sound comparable to the 2007 estimates — suggesting that Qualcomm got most of what it wants. However, other numbers suggest a different tale.

This morning, Qualcomm noted that WCDMA sales continue to explode, with 173 million devices in 2007 now estimated to be 274 million in 2008. (IDC quoted 1,150 million handsets sold in 2007). Qualcomm reports the rate of growth for WCDMA devices is 58% worldwide, 49% in Europe (where Nokia is strongest), 45% in Asia (outside of China, and 114% in the rest of world (mostly Americas, where Nokia is losing share).

Nokia doesn’t break down what % of its handsets sold in 2007 are WCDMA, but even if we assume Nokia’s handset revenues are flat in 2008, the shift from GSM to WCDMA handsets should increase the number of Nokia units paying Qualcomm royalties by at least 40%.

Qualcomm’s major licenses undoubtably have a most-favored-nation clause, and so Qualcomm would do anything in its power to avoid setting a precedent. Both companies have made it impossible to do an apples vs. apples comparison, and so the actual terms (probably visible through Qualcomm’s FY2009 10-K) won’t be known for years.
The bottom line? Even with a strong hand, Qualcomm offered Nokia something to settle. If the reported numbers are accurate, my hunch is that (avoid setting a precedent) the valuation of the IP licensed and transferred by Nokia was used to implement a 15-35% reduction in the near- term royalty payments. The financial impacts in the out years would depend on assumptions that even the two parties don’t fully understand.

Because of Qualcomm’s eagerness to go to arbitration — and what I know from studying their business model for almost a decade — I do not believe the (unsubstantiated) claim that Qualcomm cut its rate to 2%. With MFN, Qualcomm won’t be making a dramatic cut to its royalty rate, but we don’t know if (or how much) of a royalty Qualcomm pays to use Nokia patents in its chipsets.

With its concessions, Qualcomm got a 15 year revenue stream from 40% of the world’s handset market. It also won an important precedent: Nokia will pay royalties on two 4G technologies (LTE and WiMax) where Qualcomm royalty position is far less certain than for WCDMA. The rest of the industry (with the possible exception of China) will eventually follow/.

Both stocks rose on the resolution of the uncertainty. RCR Wireless News notes that the settlement will allow Nokia to re-enter the US CDMA market. A Citigroup analyst speculates that Nokia may buy Qualcomm (instead of TI) chips.

I have met a number of Nokia and Qualcomm people in my research. In some ways they are fairly similar, and (other than the money) they seem like they should be able to work together (which makes it like Qualcomm & Broadcom, but unlike Nokia and InterDigital). So when Paul Jacobs says he expects the two companies to work together, I think that’s both realistic, and will also be very good for the future of the wireless industry.

Best deal in town

This is off-topic but is something I wanted to share with my only San Diego audience of my four blogs.

One of the best kept secrets for North County parents is the City of Oceanside summer surf camp. It follows the normal day camp model — a few adults, mostly teen camp counselors — except that the kids spend all day at the beach surfing.

The program runs from 8-3 every day (except July 4th) north of the Oceanside Pier. At the end of the week the kids have a surfing contest at three levels (beginning, intermediate, advanced) judged by the counselors, who award small prizes and consolation prizes donated by local surf shops (e.g. a surfing poster).

This week was the third year in a row that our daughter did the camp, and she’s always had a great time. We encouraged some of her friends from San Pasqual to do it and the two kids also had a great time this week. Our neighbor in Oceanside can’t get his teenager to do it, but his nephews spend two weeks every year in the program. The program is open to residents and non-residents ages 8-16 who can pass a rudimentary swim test.

The best thing of all his the price — $135/week for a 7-hour camp — cheaper than daycare and a heck of a lot more fun. Unlike Carlsbad, Oceanside does not surcharge out of town participants in its recreation programs. The city has a pretty terrible website — with only last year’s brochure up as a PDF — but the Aquatics Department will mail out a form if you call them (760-435-5235).



Photo: winner of the Oceanside swim camp July 3rd intermediate competition.

Broadcom to Qualcomm: say uncle

This week I’m at the meeting of the University-Industry Development Partnership, a two-day conference up at UCI that’s trying to focus on university-industry collaboration. Because of our location, there has been some local color (besides the weather).

Interestingly, UCSD Connect is prominent here — everyone acknowledging (at least in its heyday) it as the global model of university-industry cooperation for tech startups. For example, one of the sessions was a discussion of how UCI is making a two-day conferencea second attempt to replicate Connect: this second attempt appears both to be more successful, and also to have improved on the Connect model in a couple of ways.

Another local speaker was Dr. Henry Samueli, a former UCLA and UCI engineering professor who co-founded Orange County’s largest and most successful electronics company: Broadcom. From his Broadcom billions, Samueli donated money to name the UCLA and UCI engineering schools and buy the Anaheim Ducks.

Samueli was chairman of the board of Broadcom until he stepped down May 15 due to accusations of stock option backdating. (He resolved the accusations last week with a plea bargain leading to a fine and probation).

Samueli talked about the company’s growth from its founding in 1991, its IPO in 1998 and its current run rate of nearly $4 billion/year. The engineering professor described an attitude towards corporate culture and engineers sounded very similar to that of Jacob and Viterbi’s two companies:

Hiring the best and brightest engineers is what it’s all about. If I had to pick one thing about being a successful technological innovator, it’s hiring the best and brightest technologists.

His discussion of an open communication, achievement-motivating culture also sounds exactly what we heard about Linkabit.

Its R&D intensity is about 20%, or $800 million year in R&D. As I speculated earlier, it’s far more D than R:

It’s almost all product development in the near to mid term. Almost no basic research can be afforded in that budget — only a tiny bit.

Despite this focus on development rather than research, Broadcom has aggressively patented its technologies. The number of granted patents rose from 456 in 2003, to 824, 1627, 2625 and now 3300 in 2007. He proudly pointed to an IEEE Spectrum article on patent impact using statistics compiled by the consulting firm 1790 Analytics.

For San Diego readers, the biggest interest in Broadcom is its patent infringement suit against Qualcomm that it won 18 months ago. Frankly, I thought inappropriate (and off topic) to ask about the lawsuit, but someone else did.

When asked about the issue of patent cross-licensing, Samueli said that it had many cross-license agreements. Earlier, he had noted that Broadcom would prefer to have a situation where patents were not a factor — that Broadcom could race to be first without regards to patents.

Cross-licenses thus fit Broadcom’s goal: as Samueli said, “You go do your thing and we go do our thing and leave each other alone — and rely on innovation to keep you ahead in the marketplace.”

Cross-licensing does not (of course) include Qualcomm: “We’re having these issues with Qualcomm — we’re trying to get to that point.” Obviously, Qualcomm issuing a royalty-free cross license would destroy their business model, so there is no way to reconcile to fully satisfy both sides.

Photo credit: 2006 photo of Samueli from the Los Angeles Times.