Apple Inc. (NASDAQ:AAPL) dropped a bombshell on one of its biggest partners, Qualcomm, Inc. (NASDAQ:QCOM) last Friday. Apple filed a complaint in U.S. District Court seeking $1 billion for monopolistic behavior. AAPL stock holders likely won’t be impressed with the flimsy amount — after all, Apple brought in more than $215 billion in revenues last year.
But the litigation could have a material impact on Apple stock over the long haul.
At the heart of the suit is Qualcomm’s baseband chips, which allow smartphones to connect to mobile networks. Without this core technology, you actually wouldn’t be able to do much with your device. QCOM has protected this technology with an extensive set of patents, and has established global standards for the mobile industry.
While AAPL stock saw little initial reaction — it was up less than 1% on the news. But QCOM saw action, with shares down a grueling 10%.
Qualcomm is the target of various governmental lawsuits regarding anti-competitive behavior and unreasonable royalties. Just last week, the U.S. Federal Trade Commission filed a suit (though this may ultimately be undone by the Trump administration). Then there was a similar action brought by the European Union, as well as a fine of $975 million from the Chinese government.
But the suit that has gotten most of the attention — and that’s at the heart of Apple’s own actions — is from the Korea Fair Trade Commission, which has levied a penalty of $865 million. QCOM is vigorously pushing back, claiming that its technologies are top-notch and the financial terms are within industry norms.
AAPL thinks this is laughable.
Apple says that Qualcomm is withholding rebates withholding rebates because of its cooperation with Korean authorities. AAPL also is alleging that it was coerced into buying QCOM chips, on an exclusive basis, to get relief on some royalties. This arrangement lasted from 2011 to 2016.
But for the most part, the real issue for Apple is that Qualcomm’s royalties are steep, coming to as much as 5% of the average price of an iPhone. By comparison, typical chip operators like Texas Instruments Incorporated (NASDAQ:TXN) and Broadcom Ltd (NASDAQ:AVGO) generally charge pennies per unit because of the large volumes.
Is it any wonder that QCOM is so profitable? During the past five years, the company generated a whopping $32 billion in pretax profits.
According to a report from RBC’s Amit Daryanani:
“It would be more material if AAPL gets a lower price on IP licensing vs. what they currently pay to QCOM (QTL portion of the revenues). Furthermore, in theory AAPL could procure basebands from INTC at perhaps lower ASP’s and that could be another tailwind to AAPL’s gross-margins (QCOM’s QCT revenue).”
Then there is this from Bernstein Research analyst Stacy Rasgon:
“Rather, AAPL is attempting a direct assault on Qualcomm’s basic licensing business model, attacking the ‘essential’ nature of their IP, and directly targeting QCOM’s device-level royalty model. The suit doesn’t read well for the future of the chipset relationship either.”
Bottom Line On AAPL Stock
Naturally, there’s plenty of daylight between now and any sort of decision, let alone any impact of Apple shares. Litigation is time-consuming and far from predictable.
In the meantime, the key for Apple is the upcoming iPhone 8. And there are encouraging signs that this could be the turnaround spark AAPL stock needs. The buzz is that there will be whiz-bang features like gesture and facial recognition, as well as wireless charging and OLED (organic light-emitting diode) screens, which will be thinner and perhaps even allow for bending.
What’s more, the valuation on Apple stock remains attractive, with a forward price-to-earnings multiple of just 12X. This is at a discount to other mega-tech operators, such as Microsoft Corporation (NASDAQ:MSFT) at 19X and Oracle Corporation (NYSE:ORCL) at 14 — and they certainly don’t have the kinds of products that will gin up anywhere near the excitement (or potential growth) of a new iPhone.
Tom Taulli runs the InvestorPlace blog IPO Playbook and also is the developer of an iOS app for taxes. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.