What would it take to make Qualcomm Inc.’s China problem go away, permanently? In February, the semiconductor supplier coughed up $975 million to settle charges of anti-monopoly practices in China and agreed to other painful steps that will make local rivals more competitive. Yet these actions haven’t relieved Qualcomm of its China headache. Sales in the country are still under pressure amidst the recurring nightmare of getting some licensees to honor the terms of their engagement.
Qualcomm executives don’t attribute all the company’s challenges to China but acknowledge selling products and services in the world’s biggest market for semiconductors is getting tougher for a bunch of reasons. They are hopeful about the company’s longer term prospects following the agreement that lifted the anti-monopoly cloud hanging over Qualcomm. The deal with China’s National Development and Reform Commission, (NDRC), imposed certain “rectification” actions that in the interim will curb Qualcomm’s sales growth in the country in addition to forcing the American company to provide engineering and financial supports to customers and competitors.
The resolution of a similar anti-trust dispute in the West would have taken years of tough negotiations and perhaps even landed the combatants in a courtroom but Qualcomm, recognizing the capability of China’s regulators to inflict even more pains on it, quickly signed the agreement. It indicated “disappointment with the results of the investigation” but said in a statement that it would pay the nearly $1 billion fine “on a timely basis as required by the NDRC.” Why? Because Qualcomm believes the deal with the NDRC will further open up China to the company and clarify the terms of engagement with current and future customers, according to its executives.
“The resolution has removed the uncertainty surrounding our business in China, and we will now focus our full attention and resources on supporting our customers and partners in China and pursuing the many opportunities ahead,” said Steve Mollenkopf, CEO of Qualcomm, in a statement announcing the resolution of the anti-monopoly conflict with the NDRC.
If it was only that simple. In fact, Qualcomm’s fiscal 2015 second quarter results and its forecast for the entire year belied the optimism executives tried hard to convey. Revenue rose indeed, to $6.9 billion from $6.4 billion, in the comparable year-ago quarter, but fell short of the top end of the company’s $6.5 billion to $7.1 billion forecast. Net profit tumbled, to $1.1 billion from $2 billion, during the recent quarter, due to a hefty $1 billion charge.
The outlook for the second half of the fiscal year and further out wasn’t encouraging. Qualcomm projects fiscal 2015 third quarter sales will be in the range of $5.4 billion to $6.2 billion vs. $6.8 billion for the fiscal 2014 third quarter. The company reduced its fiscal 2015 sales projection to $25 billion to $27 billion compared with a prior forecast of $26.3 billion to $28 billion.
“Clearly, we are not pleased with our reduced outlook. Accordingly, we have initiated a comprehensive review of our cost structure in QCT and throughout the company,” Mollenkopf said, during a conference call to discuss the latest results. “The goals of this review are to align our cost structure with the changing marketplace and improve efficiency. We have begun a comprehensive assessment of costs and opportunities for greater efficiency company-wide with the help of an outside expert and will be reporting on those initiatives on the third quarter earnings call.”
China isn’t solely responsible for Qualcomm’s latest and projected sales weakness. The loss of a supply agreement with Samsung Electronics for one of the Korean company’s smartphones is hurting Qualcomm’s sales. The company said sales were also hammered by changes in the smartphone market, a development analysts attributed to Apple’s dominance of the sector. With Apple sucking up most of the profits from the smartphone market, rival handset OEMs are rethinking their offerings and pushing out new product introduction timelines.
“We are guiding the second half lower due to a number of factors in QCT. First, the extent of the impact of OEM concentration at the premium tier and the impact of share loss in the [Samsung] Galaxy S6 and Note,” Mollenkopf said. “Second, the altered launch plans of the OEMs in the premium tier with some OEMs delaying launches and then OEM rationalizing their portfolio by de-emphasizing designs using our legacy parts. We are not seeing a change in design share or the competitive environment, but rather a change in timing of some 810 designs.”
China is still a hot potato for Qualcomm and other Western electronics companies, however. Many local Chinese companies pay lip service to intellectual property agreements, forcing Western firms to be wary of engagements in the country. This, combined with the Chinese government’s prickly hostility to Western companies’ domination of the nation’s high-tech market, has turned an already intensely competitive environment into a harsher terrace for component suppliers and OEMs.
Yet Qualcomm cannot afford to ignore the Chinese market. It is the largest global market for semiconductors globally and increasingly an important buyer of ICs used in mobile and networking equipment. Anchored by China, the Asia-Pacific region now accounts for more than 50 percent of the global $336 billion semiconductor market, according to the Semiconductor Industry Association.
While China’s growth has slowed in recent months, it remains the largest single consumer of semiconductors globally and this trend is expected to continue, pulling in suppliers eager to sell components to foreign OEMs manufacturing in the country as well as local electronic equipment vendors. With the Chinese government aggressively promoting the growth of local IC vendors, companies like Qualcomm have had to bend over backward to secure sales in the country despite rising complaints of IP theft and other difficulties.
In Qualcomm’s case, the company even has difficulties getting some licensees to accurately report sales of licensed products. This is in addition to outright violation of Qualcomm’s IP rights by companies that may not have signed licensing agreements with the American semiconductor vendor. Qualcomm said it has made significant headway getting manufacturers such as Huawei and ZTE to sign licensing agreement based on the deal it struck with China’s NDRC but warned that some companies aren’t cooperating.
“It is possible that in some cases it may require litigation and/or actions to compel certain licensees to honor the contracts and for unlicensed companies to execute new licenses,” said Derek Aberle, Qualcomm’s president, during the most recent conference call with analysts. “We are prepared to pursue that path if it becomes necessary.”
It would be difficult to blame Qualcomm if it plays hardball with violators of its licensing agreements and IP rights in China, considering the terms of the deal it reached with the NDRC. The company said it expects to improve relationship with Chinese authorities by:
Providing extensive engineering assistance and support to China’s mobile operators in rolling out their 4G LTE networks in China.
Working closely with Chinese handset manufacturers to build their businesses both inside and outside of China as they seek to become top global brands and leading global suppliers of smartphones.
Expanding Qualcomm’s longstanding relationship with Semiconductor Manufacturing International Corporation (SMIC), one of China’s largest and most advanced semiconductor foundries, which has led to SMIC’s major milestone of producing high-performance, low-power mobile processors using cutting-edge advanced 28nm technology.
Creating a China-specific investment fund of $150 million to further the development of mobile and semiconductor technologies, including initial investments from the fund in five innovative Chinese companies.
Why would Qualcomm or any other company agree to the above terms, which read like a memo on how not to aid the competition? It’s because the Chinese electronics market is that large and that important. Qualcomm may lose some market share as a result of the NDRC agreement but a smaller piece of the China pie is better than getting locked out completely.