Qualcomm Settlement With China’s NDRC Removes Major Speedbump

Qualcomm’s settlement yesterday with the Chinese NDRC (National Development and Reform Commission) over the company’s violation of China’s 2007 AML (Anti-monopoly Law) is a much needed closing of a chapter in the company’s history in China. The announcement finally clears a grey cloud that has sat over Qualcomm’s earnings announcements ever since the investigation had been announced in late 2013. Many Qualcomm investors have sat uneasily as Qualcomm has talked about their difficulties in China possibly impacting their earnings and the ongoing investigation into Qualcomm’s alleged monopolistic behavior. The resolution that the company reached between itself and the Chinese NDRC essentially means that Qualcomm’s business in China has been cleared up and they can now present the new government-approved licensing terms to current and future licensees of their technology.

The terms

This resolution comes as a result of the fact that the NDRC issued an Administrative Sanction Decision finding Qualcomm guilty of breaking the AML and levying a fine on them. Qualcomm will first need to pay a $975M fine. Qualcomm will need to implement multiple measures in order to satisfy their agreement with the NDRC which include offering 3G and 4G licenses on essential patents separately from other licenses to other patents and will present a patent list during negotiation.

(Credit: Patrick Moorhead)(Credit: Patrick Moorhead)

It’s important to know the circumstances where this agreement applies. It applies only to phones sold in China by companies based in China. For instance, if Xiaomi or Lenovo were to sell a phone in China, it would apply. If Xiaomi or Lenovo sold phones in India, it would not apply. Similarly, if Apple or Samsung were to sell a phone into China, it would not apply.

Qualcomm will need to charge royalties of 5% for 3G devices and 3.5% for 4G devices that do not implement CDMA or WCDMA, in each case using 65% of the net selling price of the device. While the percentages remain the same, the net selling price basis was reduced from 100% to 65%, essentially a 35% price reduction. Qualcomm will also not condition the sale of baseband chips based on the signing of a license agreement with the terms that the NDRC found to be unreasonable. But they also do not have to sell their chips to companies that are not licensees or companies that refuse to report their sales of licensed devices as required by its patent license agreement.

Free to move forward

All of this means that Qualcomm is officially sanctioned by the Chinese government to do business with and to work more closely with their partners in China.

This will also mean that Qualcomm can more effectively get their Chinese partners to pay the fees they were supposed to be paying and to use this agreement as a legal framework to do so. Incredibly, some Chinese phone manufacturers weren’t paying license fees, so after this agreement it will be difficult for them to withhold payment.

As a result, Qualcomm revised their guidance for fiscal 2015 upward by $300 million, narrowing their guidance. They also guided their GAAP earnings downward due to the $975 million charge due to the fine from the NDRC and guided their non-GAAP earnings upward, which excludes the $975 million fine.

Because the settlement was limited to phones sold into China by Chinese manufacturers, Qualcomm indicated to their investors on the investor phone call that this should not impact their profitability elsewhere.

This was an absolutely necessary move for Qualcomm as they have invested countless time and money into the Chinese market, including helping some of the biggest carriers get their LTE networks up and running. Qualcomm has also spent considerable time and money helping Chinese OEMs and ODMs improve the quality of their devices and reduce their time to market with reference designs and platforms. They also created a $150 million China-specific investment fund in order to show their commitment to China, and to very likely appease the Chinese government.

It’s hard not to wonder if most of this was politically motivated and had little to do with actual monopolistic behavior. Qualcomm has multiple competitors and they weren’t getting priced out of their customers’ devices. Qualcomm isn’t the first or the last company to be a target of the NDRC’s probes as they almost exclusively go after foreign companies with established global businesses and deep patent portfolios. The NDRC has already gone after companies like Volkswagen Audi Group as well as Microsoft, however, they have stayed away from companies like Intel who has made countless investments in China to the tune of billions of dollars in China.

Wrapping up…

Many at Qualcomm and those that are invested in Qualcomm are going to be very happy to see this chapter behind them. It also spells the beginning of a new chapter in the company’s involvement in China, which some admittedly say took too long to really cultivate. Some of their competitors, not named in NDRC complaints, pre-empted their involvement with heavy investment in China, which is ultimately what the NDRC really wants from western companies looking to do business in China. Qualcomm has finally reached the levels of what the NDRC has expected of them and they’ve now paid what the Chinese government believes to be a fair price for their practices.

Qualcomm likely won’t encounter similar behavior in other regions due to their views on essential patents, patent law and protection, but there is still a small chance they could see problems in the future if their cellular wireless dominance continues.

Net-net, this is all good news for Qualcomm as they can now get onto business in China.