Thursday, July 24, 2008

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.


QCOM Exec 02 said...

The reason no specifics have been post is because Nokia will be paying QCOM no royalties. Understandably, QCOM doesn't want this known, so the secrecy of the specifics was part of the deal.

QCOM Exec 02 said...

To say "I have met a number of Nokia and Qualcomm people in my research. In some ways they are fairly similar" makes me question your credentials. In almost no way are we similar.