Another day, another headline on Apple’s legal battles — but this one could signal a promising shift for stockholders.
A few weeks ago, we published a piece on the growing trend of technology companies that are spending more on litigation and patent acquisitions than on R&D. A prime example was Apple (NASDAQ:AAPL), a company that’s cut research and development expenditures from 8% of annual revenue to just over 2% in the span of a decade, and now spends more on lawyers and related activity than it does in the lab. I pointed out that Apple’s seeming obsession with litigating archrival Samsung into submission was leaving the company at risk of losing its edge.
There was another risk I failed to consider, but it just blew up in Apple’s face in big way: When a fight starts getting dirty and your opponent also happens to be your biggest component supplier, they have a lot more leverage than you might realize. Especially when there’s no one else able to pick up the slack.
You see, Samsung makes the CPUs in Apple’s iPhones and iPads … and Samsung just hiked the price it charges Apple for those mobile CPUs by 20%.
Ouch. A big part of Apple’s tremendous growth story has been the margins it’s able to command on its products. For example, IHS iSupply pegs the profit margin on a 16GB iPhone 5 at around 68%, based on a $649 non-contract price and $207 for components and manufacturing costs. Of that $207, $17.50 is the processor. Hike the cost of that component by 20% and it becomes $21, cutting into that profit margin.
More galling to Apple is the fact that this extra cash goes straight back to its rival. The Wall Street Journal thinks Apple will end up selling 200 million iPhones and iPads this year. They don’t all use the same CPU variant, but just say we applied that $3.50-per-CPU price hike across the board, and extended it for a year’s worth of production. Samsung would end up netting an extra $700 million or so … almost enough to make up for that billion dollars or so Samsung has to cough up to Apple for patent infringement.
But wait, wasn’t Apple looking at shifting mobile CPU production away from Samsung to Taiwan Semiconductor (NYSE:TSM)? Couldn’t it then avoid paying Samsung’s premium? The TSM deal is still in the negotiation phase; it takes time to ramp up a new supplier to production-level quantities even if a deal is done. And then there’s the fact that Samsung has a contract to supply Apple through 2014. So no short-term escape.
Of course, by hiking its prices, Samsung has pretty much guaranteed that its biggest customer for mobile components will take its business elsewhere the moment it can, costing Samsung the 8.8% of its annual revenue Apple currently contributes.
It kind of makes you wonder whether this kind of drawn out, tit-for-tat strategy benefits anyone involved.
Given the backdrop of all this squabbling, it was refreshing to hear that Apple has taken a different tack with HTC, another mobile rival it has been engaged in a lengthy legal patent spat with. Apple had accused HTC of copying iPhone features in its smartphones, while HTC claimed Apple’s iPads and MacBooks were infringing on its wireless patents. This battle has been in the courts since 2010.
Apple sent out a joint press release on Monday announcing the companies had settled their differences by signing a 10-year license agreement. Terms weren’t provided, but Bloomberg thinks it involves HTC paying Apple between $6 and $8 per phone its sells.
Perhaps even more telling were the quotes from Apple CEO Tim Cook and HTC CEO Peter Chou which were included on the press release.
Cook: “We are glad to have reached a settlement with HTC. We will continue to stay laser focused on product innovation.”
Chou: “HTC is pleased to have resolved its dispute with Apple, so HTC can focus on innovation instead of litigation.”
Innovation over litigation. Could it be that we’re seeing a light at the end of the tunnel? They’re certainly saying the right things.
Apple’s stock is down over 20% in the past month, at least partially because of a loss of confidence in the company’s ability to innovate and come up with new products. It’s released incremental updates of iPads, iPhones, iPods, iMacs and MacBooks for several years now and worse, been caught playing catch-up to Google (NASDAQ:GOOG) and Amazon (NASDAQ:AMZN) with a small-form-factor tablet.
The Samsung battle is so big and so complex that it’s not going to go away so easily, but the HTC settlement gives some hope that Apple management has been listening and is preparing to shift resources and focus back to new product development.
If so, it’s good news for anyone holding Apple stock — because that’s the only way the company is going to develop another breakthrough product that keeps the company growing instead of slipping into slow decline.