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It's never easy being a patent king. Just ask companies like Rambus (Nasdaq: RMBS ) and Tessera Technologies, which have spent untold millions waging legal battles to defend their intellectual property, which they rely upon to generate the licensing fees and royalties that make up the bulk of their revenues. You can be sure that any company trying to collect royalties on a large scale from an industry will create a lot of animosity among the companies it targets, not to mention the governments that support these companies.
For Qualcomm (Nasdaq: QCOM ) , the animosity it's faced has been especially bitter, due to the stakes at play. With the company traditionally seeking a royalty in the 5% range on the sale of every wireless device that uses its CDMA technology, and with CDMA forming the basis of every true 3G network on the planet, it's no surprise that the company has found itself in legal disputes with everyone from handset manufacturers such as Nokia (NYSE: NOK ) and Ericsson to chip developers such as Broadcom (Nasdaq: BRCM ) , to government bodies such as the European Union and South Korea's Fair Trade Commission. And as you might guess, these legal battles can carry on for quite some time.
Dealing with one courtroom headache after another, it's not surprising to see a patent king decide that it's better off compromising on its licensing and/or royalty rates, simply to bring down its legal expenses and start collecting revenue. Qualcomm appears to have done that with Nokia in 2008, settling its dispute with the world's largest cell phone manufacturer by agreeing to a $2.5 billion licensing payment, but also a royalty rate that's widely believed to be much lower than Qualcomm's traditional rates. Now, it looks as if Qualcomm has done it again, agreeing to a 15-year deal with the world's No. 2 phone manufacturer, Samsung, that appears to tie a $1.3 billion payment with a lower royalty rate than what Samsung has historically paid.
The market doesn't seem too bothered by the Samsung deal -- rather, it seems pleased that Qualcomm got a deal worked out without more courtroom drama. But I have to think that while one such compromise can be written off as a unique event -- especially with Nokia having a strong patent portfolio of its own -- a second compromise amounts to a trend.
You have to wonder what the suits at LG, the world's third-largest phone manufacturer, are thinking as they read about the Samsung deal. And for that matter, how about the execs at Sony Ericsson, Motorola (NYSE: MOT ) , Research In Motion (Nasdaq: RIMM ) , and Apple (Nasdaq: AAPL ) ? If Apple's royalty rate to Qualcomm is in the 5% range, the company could be paying more than $25 for every 3G iPhone sold. I can't imagine that sitting too well with Steve Jobs.
As far as tech companies go, Qualcomm is still a relatively low-risk investment. The company continues to generate stunning amounts of cash -- even with revenues for the fiscal year that just ended declining 7% thanks to the global recession, free cash flow (excluding Nokia's licensing payment) grew 25% to $4.4 billion. And as 3G phones continue growing as a percentage of global cell phone sales, Qualcomm's royalty and chipset revenues should steadily move higher.
But in the aftermath of the Nokia and Samsung deals, the long-term growth outlook for Qualcomm's royalty business doesn't look as rosy as it might have a few years back. And with Qualcomm saying on its conference call that it still has disputes with two licensees, investors shouldn't be shocked to see more compromise agreements arrive.