Why Qualcomm Folded to Nokia
Qualcomm struck a patent deal with Nokia when it seemed a Delaware court wouldn't go its way. So ends mobile's biggest, costliest battle
The longest running, highest-stakes poker game in the history of the mobile industry came to a surprising conclusion July 23, when Nokia (NOK), the world's largest mobile-handset maker, and Qualcomm (QCOM), the largest chipmaker for cell phones, suddenly agreed to settle their legal battles over intellectual property and royalties, just as a pivotal court case in Wilmington, Del., was about to begin. The accord will have wide-ranging implications for both companies and the future of the mobile sector.
The two sides said they have agreed to drop all legal complaints against each other in the U.S., Europe, and Asia. The companies also struck a 15-year licensing deal that gives Nokia rights to a wide portfolio of Qualcomm patents, covering a wide range of different-generation mobile-phone standards. Nokia will pay Qualcomm an up-front sum and ongoing royalties, but the companies did not elaborate on terms. The Finnish phonemaker agreed not to use any of its patents directly against Qualcomm, allowing the U.S. chipmaker to integrate Nokia technologies into its chip sets. Nokia will also hand over to Qualcomm several essential patents in fourth-generation wireless networking technologies known as Long Term Evolution (LTE) and WiMAX.
The agreement, announced after European markets closed, sent Qualcomm shares soaring 16.82%. (Qualcomm, which was supposed to report earnings July 23, postponed its earnings announcement to July 24). Nokia shares were up 4%, with analysts predicting a number of upsides, including a potential increase in the Finnish phonemaker's U.S. business.
So ended a standoff that crimped the expansion of both companies' businesses, cost each side hundreds of millions of dollars in legal fees and threatened to fragment the mobile industry's approach to fourth-generation services. "It has been a long time but it has been worth it," says Rick Simonson, Nokia's chief financial officer, explaining that the Finnish phonemaker was able to negotiate a much lower royalty rate than the one it was paying when a licensing agreement between the two companies expired in April 2007. He declined to be specific.
Billions of dollars were at stake. "There is a reason this was such a decisive battle," says Ben Wood, director of CCS Insight, a British mobile consultancy. "If you are striking a 15-year agreement and Nokia is making half a billion mobile handsets every year, even a fraction of a percentage point has massive implications for both sides."
Qualcomm will benefit immediately by receiving a lump sum in royalties—likely more than $1 billion for the past year. Just in calendar year 2009, the royalties could add about 30¢ per share to Qualcomm's earnings, boosting them from $2.50 to $2.80, says Mark McKechnie, an analyst with American Technology Research.
San Diego-based Qualcomm, which gets about two-thirds of its profits from licensing fees on its patents, has been refusing to accept payments from Nokia ever since the contract it had with the phonemaker expired 15 months ago, preferring to defer hundreds of millions of dollars in royalties until a new bargain was struck.
At issue was how much Nokia—and the rest of the industry—should pay to license Qualcomm's patents (BusinessWeek.com, 10/17/07) for third-generation mobile technology. When 3G mobile standards were being developed about a decade ago, the San Diego company held key patents on the underlying technology, known as W-CDMA, that were adopted by the industry. Qualcomm agreed to license those technologies to other companies on reasonable terms, and, as a result, its patented inventions became an integral part of 3G.
But Nokia argued that the royalties Qualcomm demanded were too high relative to the value of the company's patents, and teamed up with a half-dozen other tech firms to try to force Qualcomm lower. The Finnish company filed a number of lawsuits and, two years ago, asked the European Commission's antitrust division to investigate Qualcomm's licensing fees. In their original complaint, Nokia, Broadcom (BRCM), Ericsson (ERIC), Texas Instruments (TXN), NEC (6701.T), and Panasonic Mobile Communications (MC) alleged that Qualcomm overcharged for its intellectual property and had used potentially abusive techniques to prolong its dominant position in mobile-phone technology. On July 23, Simonson said Nokia will drop its EU complaint. "Seeing as Nokia was the driving force for this complaint, we think that this will effectively end the EU complaint of the other plaintiffs," said a research note from Richard Windsor, a mobile analyst at brokerage Nomura (NMR).
What led to the breakthrough just hours before the trial in Delaware was about to begin? On July 23 a German federal patent court ruled that a Qualcomm GSM patent asserted against Nokia was invalid, the third consecutive court to conclude that Qualcomm's patent claims against Nokia were without merit. Britain's High Court and the U.S. International Trade Commission also rejected Qualcomm GSM claims. But it was the Delaware case that was the most important in the dispute, deciding the key issue of W-CDMA royalties. Analysts speculate that Qualcomm may have settled because it feared it wouldn't win that one, either.
Qualcomm was effectively asking for a royalty rate of about 4.5% of the phone's average selling price, an amount "which is fairly crippling in an industry with operating margins of 5% to 15%," according to a research note from mobile-industry analysts in the London office of Dresdner Kleinwort. Nokia wanted to pay less than 3%. "With almost the entire industry on the side of Nokia and with the principles of FRAND (Fair, Reasonable, And Non-Discriminatory) terms being widely accepted by almost all industry players for the longer-term well-being of the industry itself, we believe that the legal argument may have been in Nokia's favor," the research note said.
Pressed on what led up to the last-minute agreement, Simonson says it came as a surprise to Nokia. "It was unlikely and unpredictable," he says. "We all happened to be in Wilmington, Del., and when there was movement we were well prepared and it came together."
The legal battles were taking a toll on Nokia and Qualcomm's businesses, say analysts. One of the disputes led to a temporary ban on importing handsets containing the San Diego chipmaker's technology into the U.S. And Nokia's court battles with Qualcomm have adversely affected the Finnish phonemaker's CDMA business and its dealings with U.S. wireless carriers, says CCS Insight's Wood. "Psychologically, U.S. carriers were very worried about dealing with Nokia while the patent dispute was raging, and it was almost impossible for Nokia to deliver mobile phones for CDMA networks without working with Qualcomm," says Wood. "The agreement will help Nokia's efforts in North America, which is their Achilles' heel right now."
Nokia's Simonson says, and analysts agree, that the end of the disputes between Nokia and Qualcomm will also boost the industry's efforts to advance fourth-generation mobile networks.
The agreement could also put pressure on other companies, such as Texas Instruments and Broadcom, to settle with Qualcomm.
One downside for Qualcomm: If Nokia has obtained a discount on royalties, analysts say other big mobile handset makers such as Motorola (MOT), Samsung, and LG may demand a similar cut.