Broadcom's Bid for Qualcomm Gives Apple Another Reason to Keep Fighting

Going into November, it already looked as if Apple Inc.  (AAPL) and Qualcomm Inc.'s (QCOM) bitter dispute over iPhone and iPad royalties was unlikely to be settled quickly, given how much the companies were at odds over what Apple owed and the battle's implications for Qualcomm's broader patent-licensing business.

Exiting November, the odds of a settlement happening in the near-term seem lower still. And not just because Apple and Qualcomm have filed fresh lawsuits against each other.

With major Apple supplier Broadcom Ltd.  (AVGO) having launched an ambitious bid to acquire Qualcomm and suggesting it's ready to overhaul Qualcomm's licensing practices if it succeeds, Apple has little incentive for now to end its fight.

On Nov. 29, Apple sued Qualcomm for allegedly infringing at least 8 power-management patents via its Snapdragon 800 and 820 processor lines (widely used in Android phones). The next day, Qualcomm filed three lawsuits against Apple in a federal court based in its hometown of San Diego, alleging Apple infringes 16 non-standards-essential patents (related to RF, memory, imaging and other technologies) that are "implemented outside the modem."

Qualcomm also used five of those patents to file a new complaint with the ITC, through which the company is seeking U.S. import bans on iPhone 8 and X models relying on Intel Corp.  (INTC) modems (such as the ones sold by AT&T Inc. (T) and T-Mobile US Inc. (TMUS) ). This follows an ITC complaint made over the summer through which Qualcomm is seeking bans on Intel-powered iPhone 7 models. An initial ruling on that complaint is expected in early 2018, but a final ruling (subject to potential Presidential veto) isn't expected until late 2018 or early 2019.

Apple kickstarted the festivities in January by suing Qualcomm for $1 billion in a San Jose court over withheld iPhone modem rebate payments -- the companies differ on Qualcomm's reasons for doing this -- and alleging that Qualcomm charges excessive royalties for standards-essential patents and threatens to stop supplying chips to phone makers who don't agree to unfair licensing terms. A few months later, Apple ordered its contract manufacturers to stop paying Qualcomm royalties owed on sales of iPhones and 4G-capable iPads, a move that -- together with an unnamed licensee's decision to withhold royalties -- has badly stung Qualcomm's bottom line.

Qualcomm, which is also dealing with disputes with U.S., Korean and Taiwanese regulators, has responded by suing both Apple and its contract manufacturers for infringement. And in early November, it sued Apple for allegedly breaching a software license by sharing confidential information with Intel. The company still supplies Apple with modems that are used in a large percentage of shipped iPhones and 4G iPads, as well as the 4G Apple Watch, along with complementary chips such as RF transceivers and power management ICs.

A pair of late-October reports indicated Apple is prepping 2018 iPhones and iPads that don't rely at all on Qualcomm modems. But since then, KGI Securities has reported Apple plans to use Gigabit LTE-capable modems from both Qualcomm and Intel in next year's iPhones. On the other hand, Fast Company has reported Apple is "leaning heavily" towards using Intel modems within 5G-capable iPhones (due in 2019 or 2020), and that its 5G work with Qualcomm "has been limited."

By causing Qualcomm's shares to tumble into the 50s and stay there, Qualcomm's disputes with Apple and others created an opening for Broadcom, whose shares are up over 50% this year, to make an unsolicited $70-per-share cash/stock bid for Qualcomm. A bid that would cost $130 billion if Qualcomm closed its pending $47 billion acquisition of NXP Semiconductors NV (NXPI) under the original deal terms (NXP shareholders are pushing for better terms).

And from the looks of things, Broadcom's management signed off on this ambitious gambit partly out of a belief that it's uniquely positioned to quickly put Qualcomm's licensing disputes to rest while still making the acquisition pay off over the long run with the help of cost and product synergies.

Jim Cramer and the AAP team hold positions in Apple, Broadcom and NXP for their Action Alerts PLUS Charitable Trust Portfolio. Want to be alerted before Cramer buys or sells AAPL, AVGO or NXPI? Learn more now.

During a conference call held with Bernstein, Broadcom CEO Hock Tan said he saw a chance to "rationalize and restructure" a Qualcomm licensing business that he felt was angering mobile OEMs. Given that Apple is Broadcom's largest client — it buys Broadcom's Wi-Fi/Bluetooth combo chips, RF chips, touch controllers and more recently its wireless charging chips — it's hard to imagine Broadcom closing a Qualcomm deal without having a settlement worked out with Apple in advance, or at least being well-positioned to quickly strike one.

And here, Broadcom's status as the world's biggest maker of supply-constrained FBAR filter chips (extensively used in iPhone RF subsystems) gives it some leverage of its own. Should it acquire Qualcomm, one could see Broadcom working out a "grand bargain" with Apple through which it agrees to cut Apple's royalty payments in exchange for chip-purchasing commitments, perhaps ones that include Qualcomm modems.

Of course, Broadcom needs to acquire Qualcomm first, and Qualcomm (unsurprisingly) has rejected Broadcom's bid as inadequate. In addition, some big Qualcomm investors -- possibly just making an opening offer -- have said they'd only agree to a bid of $80 per share or more.

Broadcom reportedly plans to respond to Qualcomm's rejection by going hostile with its bid. CNBC reports Broadcom will aim to replace Qualcomm's entire board at a 2018 annual meeting that's expected to be held around March (the deadline for filing nominees is Dec. 8). Bloomberg, meanwhile, reports that Broadcom doesn't plan to up its bid "until closer" to the annual meeting. Reuters previously reported Broadcom is thinking of upping the stock portion of its bid, which for now is just $10 per share.

Translation: The Broadcom-Qualcomm battle is probably at least a few months away from being resolved, at least unless Broadcom gets cold feet about the deal's price tag (a price tag that could rise further if Qualcomm agrees to a higher NXP deal price) or the banks financing the bid do so. For the moment, there aren't any signs of either event happening.

And if Qualcomm investors feel that shares will fall back into the 50s should Broadcom's bid fail, the odds of Broadcom winning over many Qualcomm shareholders with, say, a $75-per-share bid, are pretty good.

For all these reasons, Apple has every incentive to keep battling Qualcomm for now. Both because a successful Broadcom bid could yield a much more favorable licensing deal than what Qualcomm is currently offering, and because the pressure placed on Qualcomm's shares by the dispute's existence makes Broadcom's bid more attractive to Qualcomm shareholders.

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