Despite Massive Setbacks in China, Qualcomm Still Benefits

China's government is coming down hard on Qualcomm, causing the company to lose lucrative royalty revenue.

Jul 30, 2014 at 7:00PM

Qualcomm (NASDAQ:QCOM) isn't a stranger to China. But while the company's done business in the region for decades, lately China hasn't been too kind to Qualcomm. The country is already in the middle of investigating the company for monopoly practices and, to make matters worse, Qualcomm recently said Chinese businesses aren't paying device royalties owed to the company.

Same country, new problems
In addition to selling mobile processors, the company makes much of its revenue from baseband chips that connect mobile devices to cellular networks. Qualcomm is a leader in the mobile chip space, typically being several generations ahead with its chip technology than other companies. The Chinese government's investigation into Qualcomm's business practices isn't anything new, but last week a state-run newspaper said the company indeed does have a monopoly on wireless communication standards.

Receiving a monopoly ruling against Qualcomm doesn't necessarily mean it broke any Chinese antimonopoly laws, but the investigation is hurting the company's revenue. The company said last week in an SEC statement that the monopoly probe made it harder to collect licensing fees for its technology.

As The Wall Street Journal recently said, Qualcomm makes about 29% of its revenue from licensing its 3G and 4G patent technology, but makes about 77% of its pretax profits from those fees. As China clamps down on the company, those important royalty fees are being squeezed.

Though the company hasn't specified just how much its royalties are suffering, Qualcomm said in a statement:

We also believe that certain licensees in China currently are not fully complying with their contractual obligations to report their sales of licensed products to us (which includes certain licensees underreporting a portion of their 3G/4G device sales and a dispute with a licensee) and that unlicensed companies may seek to delay execution of new licenses while the NDRC investigation is ongoing.

So not only is the monopoly probe hurting current licensing negotiations, but some companies in China are underreporting the amount royalty fees they owe to Qualcomm.

Qualcomm just ended its fiscal third third quarter 2014 and beat most analysts' expectations. The company posted revenue of $6.81 billion, up 9% year over year. But the uncertainty from China leaves the company in a difficult position in one of it's most lucrative markets.

Still lots of potential
Despite the setbacks, there's no way Qualcomm can back off of its China ambitions. The country is in the middle of a major 4G LTE rollout, which will bring both chip and baseband revenue for the company, as well as additional licensing royalties.

China Mobile (NYSE:CHL) -- the world's largest mobile network by subscribers -- has already launched part of its TD-LTE network, increasing its number of 4G subscribers from 1.3 million in February to 14 million at the of June. By the end of 2014, China Mobile says it will have 50 million 4G subscribers.

China Mobile was the first network carrier in China to receive government licenses to sell 4G LTE connectivity to consumers. China Telecom and China Unicom just received LTE test licenses last month and are limited to just 16 cities. But these licenses are step in the right direction in boosting the country's 4G connections and creating better competition between the three major carriers. China Mobile has 790 million subscribers alone, and less than 2% of those customers are currently connected to a 4G network.

China is one of Qualcomm's largest markets right now and accounted for nearly half of all the company's revenue in fiscal year 2013. Despite the investigation into Qualcomm and its impact on licensing revenue, as China Mobile and other telecoms expands their 4G coverage, the huge increase in those network connections will help push the company's royalty revenues even higher, and open up new avenues for the company to sell its baseband chips to smartphone makers.

Chris Neiger has no position in any stocks mentioned. The Motley Fool recommends China Mobile. The Motley Fool owns shares of Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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