Imagination Technologies, which once supplied Apple (NASDAQ:AAPL) with GPU designs, recently agreed to sell itself to Canyon Bridge, a Silicon Valley-based private equity firm backed by the state-owned Chinese fund Yitai Capital. Canyon Bridge will pay 550 million pounds ($743 million) for the U.K.-based chip designer.

The sale might seem unremarkable, but it might send ripples across the market that could hurt Qualcomm (NASDAQ:QCOM), the biggest mobile chipmaker in the world. To understand how this could happen, we should take a closer look at Imagination and how its technologies could help Chinese chipmakers gain the upper hand in the chipmaking market.

A graphical representation of a computer chip.

Image source: Getty Images.

Why Imagination sold itself

Imagination licenses designs for PowerVR mobile GPUs, MIPS embedded microprocessors, and other wireless processing components. Nearly half of its revenues come from Apple, which licenses Imagination's PowerVR GPU designs in its A-series and S-series chipsets.

In April, Apple abruptly announced that it would stop licensing Imagination's technologies within "15 months to two years" in favor of producing its own in-house GPUs. Imagination's stock plummeted to a multiyear low, and the company put itself on sale. Apple, which owned an 8% stake in Imagination, considered buying the chipmaker but eventually walked away.

Why China wants Imagination

Even before Apple's stunning decision, the Chinese government had been eyeing Imagination's mobile GPU technologies to strengthen its domestic semiconductor industry. Last May, the state-backed Tsinghua Unigroup quietly acquired a 3% stake in Imagination. At the time, Liberum analysts warned that Apple was "unlikely to want Imagination's technology to go to China."

Tsinghua previously tried to buy memory chipmaker Micron and a stake in data storage provider Western Digital, while Canyon Ridge recently tried to buy Lattice Semiconductor (NASDAQ:LSCC). All three deals were shot down by U.S. regulators on grounds of national security. 

Tsinghua also attempted to buy stakes in several Taiwanese IC makers, but those attempts were blocked for similar reasons. Nonetheless, all those moves indicate that the Chinese government desperately wants to improve its domestic semiconductor industry with foreign technology.

How this impacts Qualcomm

Qualcomm is Imagination's main rival in the mobile GPU space. Back in 2009, Qualcomm acquired AMD's mobile chipset business, which added the Adreno GPU (an anagram for Radeon) to its portfolio.

Qualcomm integrates Adreno GPUs with its own Snapdragon chipsets. However, Qualcomm's biggest rival, MediaTek, uses PowerVR GPUs with its higher-end CPUs -- indicating that PowerVR is a viable alternative for chipmakers that don't want to use Snapdragon SoCs or license Qualcomm's technology. OEMs that already use PowerVR GPUs include HTC, Sony, and Xiaomi.

A Snapdragon 835 SoC.

A Snapdragon 835 SoC. Image source: Qualcomm.

China was already a tough market for Qualcomm. Chinese regulators fined the chipmaker $975 million in 2015 and forced it to slash its licensing fees for Chinese OEMs. Big OEMs like Huawei and Xiaomi are producing their own first-party mobile SoCs, which reduces Qualcomm's market share.

Huawei's HiSilicon chipmaking subsidiary currently licenses Mali GPU designs from Softbank's ARM Holdings and Vivante for its Kirin SoCs. Both designs are generally considered less powerful than PowerVR GPUs. Tsinghua Unigroup, which owns the Chinese chipmakers Spreadtrum Communications and RDA Microelectronics, licenses PowerVR GPUs in its chip designs.

Since the Chinese government will own PowerVR through Canyon Bridge, state-backed chipmakers like Tsinghua will likely gain royalty-free access to those technologies -- which would improve the quality of their homegrown chips in comparison to Qualcomm's Snapdragon SoCs.

A slow but troubling trend

I'm not saying that Canyon Bridge's purchase of Imagination will immediately dent Qualcomm's chip sales in China. But the writing's on the wall -- Chinese OEMs are producing more first-party chips to cut Qualcomm out of the loop, while state-backed funds and chipmakers repeatedly attempt to strengthen the domestic semiconductor industry.

The acquisition of PowerVR was just a small victory for Chinese chipmakers, but it marks progress toward cutting U.S. chipmakers like Qualcomm out of the loop. If Qualcomm doesn't watch its back, smaller, state-backed chipmakers like Spreadtrum could eventually render it obsolete in China (and beyond) with acquired "best in breed" technologies like Imagination's PowerVR GPUs.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.