Why Qualcomm Shares Dropped Today

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Editor's note: The FTC officially charged Qualcomm shortly after this article was published. 

Sometimes too much power can be a bad thing, at least if it attracts the attention of antitrust regulators. Shares of mobile chip giant Qualcomm (QCOM 1.45%) fell by over 4% Tuesday after Bloomberg reported that the company could be facing yet another antitrust suit, this time on its home turf in the U.S. At issue are Qualcomm's licensing practices, which may be considered anticompetitive.

Qualcomm has developed a massive intellectual property portfolio over the decades, and much of the company's technology is critical to the way that modern mobile devices operate and connect with cellular networks. By law, patents that are deemed standards-essential must be available to license by other companies (including competitors), but at fair, reasonable, and non-discriminatory rates, a concept known as FRAND. Back when the smartphone market was fraught with IP litigation in 2012 and 2013, the topic of FRAND licensing came up quite a bit, as many companies back then attempted to weaponize patents and block competitors by demanding exorbitant royalties.

The challenge is that FRAND is a pretty vague concept, and while in some cases it's quite obvious that the demanded rates aren't fair nor reasonable, Qualcomm's case is unique given how dominant it is within the mobile value chain. No one has a mobile-centric patent portfolio as comprehensive as Qualcomm's.

Party like it's 2014

Qualcomm initially disclosed that the Federal Trade Commission had opened up an investigation way back in November 2014, and that investigation is what may be resulting in the antitrust suit. Here's the snippet from Qualcomm's 10-K that year:

Federal Trade Commission (FTC) Investigation: On September 17, 2014, the FTC notified us that it is conducting an investigation of us relating to Section 5 of the Federal Trade Commission Act. We understand that the investigation concerns primarily our licensing business, including potential breach of FRAND commitments. If a violation of Section 5 is found, a broad range of remedies is potentially available to the FTC, including imposing a fine or requiring modifications to our licensing practices. Given that this investigation is in its early stages, it is difficult to predict the outcome of this matter or what remedies, if any, may be imposed by the FTC. We continue to cooperate with the FTC as it conducts its investigation.

It's worth noting that around that time, Qualcomm was already in the midst of another antitrust investigation brought by China's National Development and Reform Commission (NDRC), a case that the company settled in 2015 for $975 million while also agreeing to change its ways regarding its licensing practices in the Middle Kingdom.

Qualcomm's most recent 10-K references the FTC investigation using similar language, but adds a little bit more detail. The investigation appears to focus on IP around baseband modems: "The FTC has notified the Company that it is investigating conduct under the antitrust and unfair competition laws related to standard essential patents and pricing and contracting practices with respect to baseband processors and related products."

With FRANDs like these...

The news comes as Qualcomm remains embroiled in antitrust investigations in other countries. South Korea filed suit just last month, imposing a fine of $853 million that Qualcomm is fighting through appeals. Prominent customers LG Electronics and Samsung are both located in South Korea, although Samsung is particularly important to Qualcomm's business. Samsung and a certain company from Cupertino represent a massive percentage of Qualcomm's sales, although this figure has fallen from 49% in fiscal 2014 to "just" 40% in fiscal 2016, according to the most recent 10-K.

There are also similar investigations currently under way in the European Union and Taiwan. Might as well add the U.S. to the mix. If this all plays out badly, Qualcomm could be on the hook for numerous hefty payouts to settle the investigations, which could dramatically hurt its most profitable business. Qualcomm's chip business generates more revenue, but the licensing business brings in way more profit.

Data source: SEC filings.

So yeah, it makes plenty of sense why investors are nervous right about now.