Apple Inc. (NASDAQ:AAPL) started off 2017 by launching a $1 billion lawsuit against Qualcomm, Inc. (NASDAQ:QCOM). AAPL accused QCOM of forcing it to pay inflated royalties and withholding payments after AAPL cooperated with regulators investigating Qualcomm. QCOM stock dropped 12% after the suit was filed and has yet to recover. Now the Apple modem supplier is fighting back.
The next move in this battle is Qualcomm suing Apple, citing, “Apple’s efforts to devalue the fundamental Qualcomm technologies empowering the iPhone.”
The Apple Lawsuit
Apple filed a $1 billion lawsuit against QCOM on Jan. 20. The legal action centered around the royalties paid for the Qualcomm modem that has been exclusively powering cellular connectivity for every iPhone — except the iPhone 7 (more on that shortly).
The Apple lawsuit accuses the company of overcharging on royalties covering standard essential patents. It also claims QCOM was double-charging on the Qualcomm modem used in the iPhone, forcing Apple to pay for the component, and then pay a second time in the form of a separate licensing fee.
AAPL says QCOM was pressuring carriers to refuse to sell iPhones if they were equipped with a modem made by rival Intel Corporation (NASDAQ:INTC), after Apple announced that for the first time, Intel would replace QCOM as the modem supplier for some of its iPhone 7 smartphones. It also accused the company of collecting royalties for features it had no involvement with, including TouchID fingerprint readers.
Finally, AAPL accused QCOM of withholding roughly $1 billion in rebates after Apple cooperated with South Korean antitrust regulators investigating QCOM.
Retaliation: Qualcomm Suing Apple
QCOM filed its answers and counterclaims to the Apple lawsuit on April 10. Qualcomm suing Apple is now part of the legal entanglement as QCOM seeks financial damages from the company. In its claim QCOM states:
“Apple could not have built the incredible iPhone franchise that has made it the most profitable company in the world, capturing over 90 percent of smartphone profits, without relying upon Qualcomm’s fundamental cellular technologies. Now, after a decade of historic growth, Apple refuses to acknowledge the well established and continuing value of those technologies. It has launched a global attack on Qualcomm and is attempting to use its enormous market power to coerce unfair and unreasonable license terms from Qualcomm.”
QCOM is not just defending against the Apple lawsuit, it’s going on the offensive.
The End Game for QCOM
The Apple lawsuit against QCOM ultimately boils down to reducing costs. An LTE modem is one of the more expensive iPhone component costs. With sales softening, AAPL is looking for ways to reduce costs and squeezing its suppliers is a tried and true method for protecting margins. Letting Intel replace the Qualcomm modem in some iPhone 7 models was an attempt to do just that. With QCOM facing regulatory scrutiny over its licensing practices, Apple also saw the opportunity to reduce its costs.
Qualcomm is not just trying to force AAPL back to the table, it’s in damage control mode. Together with Samsung Electronics Co Ltd (OTCMKTS:SSNLF), Apple accounts for 40% of QCOM annual revenue. A material change in the component and royalty payments paid by either of those two companies will have a huge impact on its bottom line. In its lawsuit against Apple, QCOM is seeking to portray the company as an aggressor using bullying tactics to try to force suppliers to slash their prices. It’s also doing its best to make it clear that Intel modems are inferior, putting pressure on Apple (and others) to avoid using them.
While the real winner in all this is likely to be the lawyers, Apple seems likely to come out ahead. In a worst case scenario, it goes back to paying the same royalty rates it was since the first iPhone was released, but it’s far more likely QCOM will make concessions. Intel could also score a win.
Despite the negative publicity it has received, if AAPL and QCOM get into it deeply enough, Apple could switch to Intel modems altogether for the iPhone. Qualcomm stands to lose one of its biggest customers and its royalty revenue is under attack — the best it can hope for is to minimize the damage and hope for a settlement that at least comes close to preserving the status quo.
As of this writing, Brad Moon did not hold a position in any of the aforementioned securities.