When a product is mature, the way to increase profits is to gain greater control over your supply chain and cut costs ruthlessly. That’s what Apple Inc. (NASDAQ:AAPL) is doing in its dispute with Qualcomm Inc. (NASDAQ:QCOM), and that’s why QCOM stock is getting sold off quickly in Friday’s morning trade.
The spat began with a January suit accusing the San Diego radio chipmaker of overcharging, and the withholding of $1 billion in royalty payments. Apple now says it won’t pay Qualcomn royalties until its legal dispute is resolved.
As a result, Qualcomm was forced to reduce its forecast for first-quarter revenue by $500 million, and its forecast on earnings by about 30 cents per share — below the low end of previous estimates. Some of that is likely to come back after the dispute is settled, but not all of it. In response, QCOM stock has shed 3% in short order, dropping about $2 billion in market capitalization.
This clearly is a bigger hit for Qualcomm than it is a win for Apple, but we’ll look at both sides of the story.
What This Means for Apple
Apple shares were trending higher in the premarket, and will open close to the all-time high of $144.77 achieved early in April.
But that may be a misread of the situation.
The iPhone is now a mature technology, and Apple’s high iPhone prices mean it has barely 10% of the smartphone market, with various versions of Google Android from Alphabet Inc. (NASDAQ:GOOGL) holding the rest. Apple has succeeded in squeezing 79% of the sector’s profits, but there is little more it can do on that front, given the price competition.
Thus, it needs to capture control over its supply chain and cut those costs to grow profits. While the Qualcomm deal looks big, it represents less than 2% of Apple’s $55 billion in operating costs during the December quarter. It may make a marginal contribution to profit this quarter, but some of that is going to disappear when the dispute is settled.
Apple reports earnings on May 2, with analysts expecting earnings of $2.01 per share, roughly $10.5 billion, on revenues of $52.61 billion. There is hope for $2.07 per share in earnings, meaning almost 20 cents of every dollar coming into the company goes to the net income line, which is extraordinary for a company making a commodity product in a mature category.
Apple needs a new hit, and it needs one badly.
The Qualcomm Side
Qualcomm depends on royalties for licensing its intellectual property, as much as chip sales, for its profits, and these are under attack on a broad front.
Click to Enlarge This has led some analysts to claim that the company’s entire business model is at risk.
QCOM shares are down almost 20% year-to-date, and its price-to-earnings ratio of 17.7 based on last year’s earnings is only 11.2 time next year’s estimates.
Because it owns the intellectual property necessary to make a smartphone, and sets the price for licensing, Qualcomm has become the industry’s toll collector. This has made it a target not just in the U.S. but in China, where it has a long-running dispute with the government over royalty rates, and was hit with a $975 million fine in February.
As previously noted, smartphones are a mature industry. Qualcomm could still make money with chips and licenses on wireless technology for the Internet of Things, and faster 5G technology could provide a lift to earnings in the next few years. But many providers are still digesting their 4G investments, and looking for cash to buy new spectrum rights.
QCOM stock, in short, has hit a pause. It may be a pause that refreshes, but the pause will take time to pass.
Meanwhile, shares are unlikely to go anywhere fast.
Dana Blankenhorn is a financial and technology journalist. He is the author of the political polemic Saving Trumpistan, Restoring Democracy, available now at the Amazon Kindle store. Write him at [email protected] or follow him on Twitter at @danablankenhorn. As of this writing, he was long AAPL.