Qualcomm’s Profit Hurt by Dispute Over China Royalties

Qualcomm Inc. (QCOM) shares fell the most in almost three years after the chipmaker said it’s struggling to collect license revenue from handset makers in China, the world’s largest mobile-phone market, threatening profit growth.

Qualcomm yesterday gave a quarterly earnings forecast that fell short of analysts’ average estimate. The company cited missed royalty payments for chips running on the new long-term evolution standard as manufacturers fail to report phone sales or refuse to sign contracts. Licensing is Qualcomm’s most profitable business.

The stock dropped the most since August 2011, falling 6.7 percent to $76.17 at the close in New York.

Qualcomm’s disclosure signals an escalation of its challenges in China, a market the company has been touting as a main driver of future earnings growth. Even as Qualcomm sells more chips in China, Chief Executive Officer Steve Mollenkopf must work to end the royalty disputes with phone makers and resolve a government investigation into its business to get licensing back on track in the world’s most populous country.

“Qualcomm told investors that they had the China customers under contract, that it’s all worked out,” said Suji De Silva, an analyst at Topeka Capital Markets. He has a hold rating on the stock. “Now we’re getting a sense that it’s still a challenge. Qualcomm is trying to monetize its technology, and China is a more challenging market.”

Photographer: Andrew Harrer/Bloomberg

Qualcomm Inc. Chief Executive Officer Steve Mollenkopf. Close

Qualcomm Inc. Chief Executive Officer Steve Mollenkopf.

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Photographer: Andrew Harrer/Bloomberg

Qualcomm Inc. Chief Executive Officer Steve Mollenkopf.

Net Income

Net income in the fourth quarter, which ends in September, will be $1.03 to $1.18 a share, the San Diego-based company said in a statement. On average, analysts projected earnings of $1.23, according to data compiled by Bloomberg.

“We are experiencing some near-term challenges in the licensing business, particularly related to China,” Qualcomm President Derek Aberle said in a phone interview. “This is something that we will take care of. The timing is pretty uncertain.”

Separately, the company will invest as much as $150 million in Chinese startups working to develop mobile technologies. Qualcomm recently funded Cambridge Wowo, a mobile education company, and Boohee, a mobile health-care company, it said at a press conference in Beijing.

China Obstacles

Qualcomm is in a dispute with a large customer over license revenue, and other customers are under-reporting the amount of phones sold that they should have paid license fees on, Aberle said. Some other small companies in China haven’t yet agreed to pay, he said. He didn’t name any of the customers.

The company has been working to overcome obstacles in China for several quarters. In November, it disclosed that the country’s National Development and Reform Commission had begun an investigation related to an anti-monopoly law. That caused some non-licensed device makers to hold off on negotiating with the company on fees, Qualcomm said yesterday.

The Chinese government agency is looking at Qualcomm’s licensing business and its interaction with the company’s chip unit. Qualcomm has had talks with the NDRC and the timing and resolution of the investigation is still uncertain, Aberle said on a conference call.

“Whatever the resolution will be, it will likely include some form of payment” to the government, Aberle said.

The NDRC found that Qualcomm took monopolistic actions, the Securities Times reported today, citing an unidentified person close to the regulator. Emily Kilpatrick, a spokeswoman for Qualcomm, declined to comment.

Semiconductor Sales

Qualcomm predicts industrywide shipments of 1.3 billion 3G and 4G mobile devices in 2014. Of that total, the company estimates that customers will report 1.04 billion to 1.13 billion units as the basis for license revenue calculations, meaning Qualcomm won’t get paid for the technology on as many as 260 million phones this year unless it can solve the disputes and sign up new licensees, Aberle said.

“It’s a bit of a surprise,” said Mark McKechnie, an analyst at Evercore Partners LLC in San Francisco, who rates the stock the equivalent of a buy. “Two-thirds of their profits come from royalties -- it’s high-margin, good business, and the chips can’t really make up for it.”

While Qualcomm gets the bulk of its profit from technology licensing, the majority of its sales come from semiconductors, a business that is expanding. The company said it shipped a record 225 million chips in the quarter, up 31 percent from a year earlier. It’s predicting that number will rise as high as 245 million in the current quarter, which would represent a gain of 29 percent.

Phone Royalties

Third-quarter net income rose 42 percent to $2.24 billion, or $1.31 a share. Sales in the period that ended June 29 rose 9 percent to $6.81 billion, only the second time quarterly revenue has increased less than 10 percent since 2010. Analysts on average had predicted earnings of $1.06 a share on sales of $6.52 billion.

Revenue in the current quarter will be $6.5 billion to $7.4 billion, the company said, helped by higher sales of its advanced chips. Analysts on average had estimated sales of $7.13 billion, compared with $6.48 billion in the year-earlier period.

Because of its ownership of code-division multiple-access, or CDMA, technology, the company benefits from the sale of handsets even when they don’t use its chips because it charges royalties on most phones connected to modern data networks. The exception to that has been China Mobile Ltd., which has used a technology the Chinese government said wasn’t subject to Qualcomm’s licensing.

As China Mobile shifts to long-term evolution, or LTE, Qualcomm in the past has said it expected that to change, and that phones connecting to the higher-speed data standard would mean higher licensing fees.

Qualcomm’s comments yesterday indicate the company is less certain of when that will happen, as customers and potential licensees see an opportunity to delay royalty payments on LTE technology or avoid them altogether.

To contact the reporter on this story: Ian King in San Francisco at ianking@bloomberg.net

To contact the editors responsible for this story: Pui-Wing Tam at ptam13@bloomberg.net Jillian Ward

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