Sidestepping the Qualcomm Ban

Verizon Wireless' licensing deal with Broadcom sets a precedent that could leave consumers paying more for new mobile phones or service

By shaking hands with Qualcomm's worst enemy, Verizon Wireless is not just undermining Qualcomm's hard-line legal strategy, but setting a precedent that could have far-reaching consequences for wireless service providers, handset makers, and mobile-phone users for years to come.

On July 19, Verizon Wireless struck a licensing pact with Broadcom (BRCM), the victor in a patent-infringement suit against Qualcomm (QCOM) that has led to an import ban on all new phone models containing Qualcomm's next-generation wireless chips. Under the deal, Verizon Wireless agreed to pay Broadcom a $6-per-device licensing fee, subject to certain caps, to bypass the ban and continue importing new phones.

Simply put, the arrangement is unprecedented. No wireless chipmaker, be it Broadcom, Qualcomm, or Texas Instruments (TXN), has ever charged a mobile-service provider for royalties on phones containing its components or technology. Until now, only handset makers, like Nokia (NOK), Samsung, Motorola (MOT), and LG have paid these licensing fees.

But the deal with Verizon Wireless, owned jointly by Verizon Communications (VZ) and Vodafone (VOD), introduces a new model for licensing arrangements. Think of it as a shift in how royalties in the wireless industry are administered, collected, and paid—a shift that could leave U.S. consumers paying more for new mobile phones.

Passing On Costs, but to Whom?

It appears unlikely that Verizon would be willing to eat the entire $6 extra cost. It's possible the company may seek or has already arranged to recover all or some of the expense from its handset suppliers, Qualcomm, or even its subscribers. "I'd speculate that Verizon will ultimately have to pass these costs on to their customers," says John Lau, an analyst with Jefferies. Verizon begs to differ: "The price of handsets to consumers won't increase as a result of this agreement," says spokeswoman Nancy Stark.

Either way, the licensing deal could force rivals like Sprint Nextel (S) to follow suit as the critical holiday shopping season approaches for an industry that's already scurrying to compete with AT&T's (T) flashy new iPhone from Apple (AAPL). The import ban, ordered by the International Trade Commission (ITC) in June, only affects new phone models containing Qualcomm chips with a speedier technology for wireless Internet access. But with revenue from wireless calls declining, such cutting-edge devices are precisely what carriers are depending on to boost usage of mobile-data services.

The inability to introduce devices containing Qualcomm's next-generation chips would strike hard at Verizon Wireless and Sprint Nextel because their networks are based on Qualcomm's core wireless technology. And unlike Verizon, the best performer in the U.S. wireless industry, Sprint can ill-afford the ITC ban. Sprint's subscriber base has been shrinking in recent quarters, and with the iPhone selling fast, that exodus could turn into a flood, unless Sprint can spring a new best-seller of its own.

A Chorus of Wireless Comrades

The ITC ban is unlikely to be lifted any time soon, and Qualcomm has steadfastly refused to settle the case on Broadcom's terms (see, 6/8/07, "Banned: New Phones With Qualcomm Chips"). On July 20, a federal appellate court dismissed Qualcomm's appeal of the ban "for lack of jurisdiction." While President George W. Bush has the authority to overturn the ITC decision by Aug. 6, such actions are rare, and most experts consider intervention in this case unlikely.

In fact, since Qualcomm has been banking heavily on a chorus of wireless comrades urging the President to act, the defection of such an influential player marks a serious setback in that strategy. With Verizon Wireless withdrawing its support for a Presidential veto, the chances of one being granted have fallen from "60% to 70%, to 10% to 20%," according to Blair Levin, an analyst with Stifel Nicolaus.

Potential Import Bottleneck

Where does that leave Sprint? In a bind, as the ban may even inadvertently delay shipments of phones not covered by the ITC order, says Lyle Vander Schaaf, a former ITC attorney and a partner at the law firm Bryan Cove. "Customs may be stopping all things that look like communications devices. And in some circumstances, delays can be devastating." As a result, he says, it may be cheaper for Sprint to just pay the same $6-per-phone licensing charge as Verizon. Sprint says in a statement, "We're continuing to focus on efforts to encourage the (White House) to disapprove the Order."

Broadcom won't say if it's negotiating similar deals with other companies. "We remain willing to talk to others," says David Rosmann, Broadcom's vice-president of intellectual property litigation.

A series of carrier licensing deals would effectively bypass Qualcomm to resolve a nasty, years-old royalty dispute that's repeatedly threatened to disrupt the industry. "If all carriers obtain similar licenses from Broadcom, it would not be necessary for Qualcomm to negotiate to pay [these] royalties to Broadcom," explains Vander Schaaf.

Broadcom Benefits From Extra Fees

And by negotiating directly with Broadcom, carriers may be able to get a better deal than Qualcomm. "This deal was dramatically better than what we have [been offered]," argues Bill Davidson, director of global marketing at Qualcomm. While Verizon Wireless' deal limits the payments to $40 million per year and $200 million over the lifetime of the patents involved, Qualcomm says it was offered no such caps by Broadcom and would have owed billions.

Yet while the Verizon deal appears to hurt Qualcomm's legal strategy, it would help the company avoid some of the near-term sales disruptions expected under the ban. In a research note, Mark McKechnie, an analyst with American Technology Research, writes that the 5% to 10% earnings drop he expected Qualcomm to suffer in the next few quarters due to the ban may be drastically lessened by the Verizon-Broadcom deal.

Broadcom, of course, will benefit from the extra licensing fees collected from Verizon Wireless. More important, the alliance may bring Broadcom more Verizon business. "We are going to pursue a whole range of potential opportunities," Rosmann says. "This may be several times more significant than the cash payments." Eventually, the alliance could help Broadcom get handset makers to use its components in place of Qualcomm's.

"If you are in bed with one of the world's largest operators, you can influence software and handset design," says David Wu, an analyst with Global Crown Capital. "It's a godsend for Broadcom."

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