What Exactly Does Qualcomm's China Settlement Mean for Royalty Rates?
02/10/2015 9:02 am EST
Though its settlement with China’s antitrust regulators removed an issue hanging over this semiconductor company, MoneyShow's Jim Jubak still cut his target price as of yesterday, February 9, while he waits to see what this does to the stock price.
At first glance, Qualcomm (QCOM) looks like it dodged a bullet in its settlement, announced yesterday, February 9, with China’s antitrust regulators. The company agreed to pay a $975 million fine for violating the country’s anti-monopoly laws. That’s in the neighborhood of the $1 billion settlement that Wall Street had anticipated.
But the company didn’t take the feared beating on royalty rates in this settlement. True, Qualcomm will no longer be able to bundle the right to license its chips with other patents in its portfolio, an issue that has cropped up with regulators in the United States and Europe as well. On the positive side, however, the company will be able to charge a licensing rate in China similar to what it charges elsewhere in the world.
That put to rest, as far as the market was concerned yesterday anyway, worries that China would require lower royalty rates. Those lower rates in China, the concern went, would provide leverage for companies elsewhere in the world to negotiate lower licensing fees as well. Qualcomm shares rose 1.15% to $67.11 at the close in New York and then climbed another 2.79% in afterhours trading.
Not so clear. While the settlement left royalty rates in China at parity with those elsewhere in the world, China’s National Development and Reform Commission established new math for calculating royalty payments at those rates. While the royalty rate may be the same in China as elsewhere, China’s regulators said that the value of handsets that is to be used to calculate the royalty percentage will be set at 65% of the phone’s total price in China.
Does that, in effect, give Qualcomm an argument to use against customers elsewhere in the world that are demanding lower rates while still cutting the company’s effective royalty rate in China?
If I can judge by the relatively modest increase in guidance offered by the company after the settlement was announced, I think there’s a strong argument in favor of that conclusion. Qualcomm said today that it projects revenue for the fiscal year that ends in September at $26.3 billion to $28 billion. On January 28, the company said fiscal year 2014 revenue could be as low as $26 billion and as high as $28 billion. Earnings per share excluding some onetime charges (such as for paying this fine), will be $4.85 to $5.05 a share versus earlier guidance for $4.75 to $5.05. Considering how profitable Qualcomm’s licensing business is, those are relatively modest increases if this settlement really does charge China’s cell phone makers global royalty rates. (Qualcomm got 26% of its revenue from royalty fees on licensing its technology in its most recent quarter but 58% of pretax profit came from licensing royalties.)
The settlement does remove an issue hanging over Qualcomm and its share price. Qualcomm shares were down 9.71% year-to-date as of the February 9 close and climbed just 2.28% in 2014. Qualcomm is a member of my Jubak’s Picks portfolio; I’ll keep it in this portfolio while I watch to see what removing this worry does for the stock price. But I’m cutting my target price to $82 a share by December 2015 from the prior $87. (The shares are up 45.7% since I added them to this portfolio on June 15, 2009.)