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Short circuit

4 February 2015 By Robyn Mak

Chinese regulators may be about to give Qualcomm’s business in China some shock treatment. A long-running antitrust investigation could result in a whopping fine if the U.S. chipmaker is found guilty. But changes to patent fees and sales practices would have a greater financial impact.

The $117 billion tech group has two main businesses: collecting royalties on its patented technology, and selling its own mobile phone chips. Now China’s pricing regulator is looking into whether the company used its market dominance unfairly. If it finds wrongdoing, the watchdog can impose a fine of up to 10 percent of the company’s revenue in the previous year. Based on Qualcomm’s China sales – which account for half the global total– that would mean a bill as high as $1.3 billion.

Qualcomm can afford even the harshest fine: at the end of December, the debt-free company had cash and securities worth $31.6 billion. Other remedies could be more painful. Regulators might force it to lower the royalties it demands for its patents. Qualcomm currently charges Chinese handset makers around 5 percent of the phone’s retail value, while collecting just 3 percent from rival Samsung, Nomura reckons. Though royalties make up only 30 percent of Qualcomm’s global revenue, an 87 percent operating margin means they generate the bulk of its earnings.

Qualcomm could also be forced to overhaul the way it sells chips. In 2009, Korean regulators fined the company $208 million for charging lower royalties to companies that also buy its hardware. Though it’s not clear if Qualcomm does the same in China, the company acknowledged that regulators were investigating “certain interactions” between its licensing and chip operations. So-called “cross licensing” – where Qualcomm requires clients to make their patents freely available to the chipmaker and its other customers – may also be targeted. Japan’s Fair Trade Commission banned the U.S. giant from doing this in 2009.

Without bundling and cross-licensing, smaller handset makers would have fewer incentives to use Qualcomm’s chips. Manufacturers are expected to ship 400 million fourth-generation mobile devices in China by 2017. Assuming an average price of $20 per chip, each 10 percentage points of market lost would cost Qualcomm group $800 million in annual revenue. A one-off fine would grab the headlines. But investors should keep their eyes on the small print.

 

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