I'll admit, I was a little surprised to see Qualcomm Inc.'s (QCOM - Get Report) shares drop almost 7% on Tuesday on reports that Apple Inc (AAPL - Get Report) might not use its modems inside next year's iPhones and iPads.
That's mostly because the writing has been on the wall for a while -- and not just because Apple and Qualcomm are currently embroiled in a multi-billion dollar dispute over iPhone royalty payments.
What matters going forward is whether Qualcomm's legal challenges to Apple could make Apple think twice about completely ditching Qualcomm, or at least consider developing Qualcomm-powered devices as a fail-safe option. And also whether Qualcomm, whose September quarter earnings report arrives on the afternoon of Nov. 1, can close its planned acquisition of NXP Semiconductors NV (NXPI - Get Report) -- and by so doing, greatly lower its mobile chip dependence -- at a reasonable price.
Reuters and The Wall Street Journal both report that Apple is developing 2018 iPhones and iPads that don't use Qualcomm modems. The WSJ adds that Apple plans to instead rely on modems from Intel Corp. (INTC - Get Report) , which along with Qualcomm has supplied modems going into 2016 and 2017 iPhone models, and possibly also ones from Taiwan's MediaTek.
Qualcomm shares tumbled on the reports, and they're now only about $2 above a 52-week low of $48.92. Intel, which rallied last week following a Q3 beat, rose 2.5% on Tuesday and making fresh, post-dotcom bubble highs. Intel might also be getting a boost from Samsung's (SSNLF) Q3 report, which was headlined by a banner quarter for the company's chip division.
Both reports state Apple is thinking of ditching Qualcomm because the latter has withheld software needed to test iPhone and iPad prototypes. Qualcomm, for its part, insists that it's supplying fully-tested modems to Apple and providing the company with a level of support "consistent with our support of all others in the industry."
Considering what's at stake, the notion that Qualcomm is ready to throw away its considerable Apple sales over a simple unwillingness to supply testing software sounds questionable. Qualcomm is believed to supply about half the modems going into 2016 and 2017 iPhone models and has been estimated by Susquehanna Financial to be charging $12 per modem. iPhones shipping with Qualcomm modems also contain complementary chips such as RF transceivers and power management ICs, and Apple is expected to ship over 240 million iPhones next year.
Put it all together, and Qualcomm might be selling over $1.5 billion worth of chips a year to Apple. If all Qualcomm had to do to keep this revenue stream intact is supply some testing software that it had already been providing, it's hard to believe the company wouldn't agree to it.
A more likely possibility is that Qualcomm realizes Apple is likely to abandon it regardless of whether it supplies testing software, and thus no longer wants to give Apple a level of support it doesn't provide to other major clients. That makes sense both in light of how bitter Apple and Qualcomm's royalty dispute has become, and what has been reported and revealed about Apple's chip plans.
In June, Bloomberg reported that 2017 iPhones won't support Gigabit LTE download speeds -- they're supported by Samsung's 2017 flagship Galaxy phones, as well as some other high-end Android models -- because an Intel modem that supports them wouldn't be ready in time. This decision, effectively confirmed in September when a less-powerful Intel modem (the XMM 7480) was found inside the iPhone 8 and 8-Plus, was made even though the Qualcomm modem going into some of this year's iPhones (the Snapdragon X16) supports Gigabit LTE.
Not mentioned in the Bloomberg report is the fact that the Intel Gigabit LTE modem that wasn't ready in time, the XMM 7560, is also the first Intel 4G modem to support the 3G EV-DO networks still used by Verizon (VZ - Get Report) , Sprint (S - Get Report) and a handful of foreign carriers. Therefore, until Intel ships the XMM 7560 in sufficient volume, Apple has no choice but to use Qualcomm modems in those iPhone models that need to support EV-DO networks.
It's safe to assume the XMM 7560 will be ready to go for next year's iPhone and iPad launches. And with both its 2016 and 2017 modem decisions, Apple has made it clear that it's willing to use Intel modems even if they can't match the performance of rival Qualcomm parts. In addition to not supporting Gigabit LTE this year, Apple throttled the performance of Qualcomm Snapdragon X12 modems inside its 2016 iPhones to keep them from exceeding that of the Intel XMM 7360 modem going into other units. And even with this throttling, tests found that iPhone 7 units containing the X12 delivered better real-world download speeds than units containing the XMM 7360.
Throw in the fact that Intel is believed to be undercutting Qualcomm's modem pricing -- Mizuho estimates Intel's iPhone modem sales carry an average selling price (ASP) of just $8 to $10 -- and it really shouldn't shock anyone to hear that Apple is thinking about abandoning Qualcomm altogether next year.
The only thing that's arguably surprising about the latest info is that Apple is also reportedly thinking about using MediaTek, whose modems and system-on-chips (SoCs) mostly go into low-end and mid-range phones rather than high-end devices. Qualcomm has been taking share from MediaTek in the Chinese smartphone SoC market, in large part because of its 4G modem technology edge. So one possibility is that Apple is open to using MediaTek modems within 2018 iPhones going into markets that don't have cutting-edge 4G networks. Another is that it's trying to use MediaTek as pricing leverage against Intel.
Assuming Apple is intent on ditching Qualcomm, Qualcomm still has one important card to play: In July the company filed a patent-infringement complaint with the U.S. ITC through which it requested import bans on iPhones containing Intel modems, but not Qualcomm modems. An initial ruling is expected in early 2018.
However, a final decision isn't expected until late 2018 or early 2019. And much as the Obama Administration once vetoed an ITC import ban on iPhones and iPads ruled to be infringing a Samsung patent, the Trump Administration could veto an iPhone ban. The fact that Qualcomm is only seeking a partial iPhone ban does give it some political wiggle room, and it might be in Apple's interests to develop Qualcomm-powered U.S. iPhone models as a backup plan. But much is still up in the air.
One thing that the latest iPhone modem reports do make very clear, in case it wasn't already, is the wisdom of Qualcomm's $47 billion ($110 per share) Oct. 2016 deal to buy NXP. The deal gives Qualcomm a diversified chipmaker that's well-exposed to growing automotive and IoT markets, and is expected to produce $9.6 billion in sales and $2.5 billion in net income next year (not counting any M&A cost synergies). And Qualcomm can finance a large chunk of the purchase price with offshore cash.
But first, Qualcomm needs to have at least 80% of NXP shares tendered by shareholders. As of Sep. 21, only 3.2% had been validly tendered, as NXP investors (citing the big gains posted by peers over the last year) push for a higher purchase price.
Apple's reported modem plans arguably give NXP investors more leverage to demand a higher acquisition price. Expect Qualcomm's management to see its share of Apple and NXP-related questions during the company's Nov. 1 earnings call.
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