European regulators have caused headaches for Qualcomm (NASDAQ:QCOM) over the past year. They scrutinized its proposed takeover of Dutch chipmaker NXP Semiconductors (NASDAQ:NXPI), causing the deal to grind to a halt, and also examined its licensing practices in two separate antitrust probes.
One of those headaches recently faded, but another one got worse. First the good news: EU regulators finally approved Qualcomm's takeover of NXP, on the condition that it wouldn't acquire NXP's standard essential NFC (near field communications) patents. But that deal still isn't guaranteed to close, since most NXP shareholders still haven't tendered their shares.
Then the bad news: about a week after that victory, the European Commission levied a €997 million ($1.24 billion) fine against Qualcomm for its exclusivity deal with Apple (NASDAQ:AAPL). That deal, which lasted from 2011 to 2016, enabled Qualcomm to pay Apple "rebates" for the exclusive use of its baseband modems in iPhones and iPads. The EU argues that deal "illegally shut out rivals from the market for LTE baseband chipsets." Qualcomm plans to appeal the ruling, and claims that it will have "no impact on ongoing operations." However, this isn't the first time Qualcomm has been fined by regulators, and it probably won't be the last.
Qualcomm faces fines all over the world
Qualcomm's licensing business, which generates most of its pre-tax profits, owns a sprawling portfolio of essential wireless patents. These patents entitle it to a cut (up to 5%) of the wholesale price of every smartphone sold worldwide.
Many smartphone makers, which are struggling with declining margins, argue that Qualcomm's cut is too high and should be calculated based on individual wireless components instead of the wholesale price of the entire device.
Antitrust regulators agreed, and Qualcomm was hit with massive fines in China, South Korea, Taiwan, and now Europe. In early 2015, Qualcomm agreed to pay a $975 million fine in China and lower its licensing fees for Chinese OEMs.
In late 2016, it was fined 1.03 trillion won ($943 million) in South Korea for similar reasons, but it's still appealing the ruling. Last October, Taiwanese regulators fined Qualcomm 23.4 billion NT dollars ($806 million) for similar reasons. Qualcomm initially appealed that fine, but recently agreed to pay the fine in installments.
With the European fine added to that total, Qualcomm has been fined nearly $4 billion over the past three years. That's equivalent to 6% of the $71 billion in revenues Qualcomm generated over the last three fiscal years. However, Qualcomm could face even more fines in the US, since the FTC launched an antitrust probe into Qualcomm's dominance of the baseband modem market last year.
Why investors should be concerned
These probes and fines indicate that regulators don't want Qualcomm to keep charging its current licensing fees or continue dominating the baseband modem market unopposed.
If Qualcomm is forced to reduce its licensing fees across all of these markets, its profits will plunge as those higher-margin revenues dry up. If regulators pry Qualcomm away from top OEMs like Apple, competing baseband modem makers like Intel could finally gain more market share.
These fines also impact Qualcomm's ability to deliver its recent promise of delivering 57% sales growth (at the midpoint) while roughly doubling its earnings in fiscal 2019 (which starts in late September). Qualcomm claims that it can hit those lofty targets by closing its buyout of NXP, making peace with Apple (which is still suing Qualcomm over unpaid rebates and unfair licensing practices), and cutting costs by $1 billion.
However, Qualcomm still faces unpaid fines in South Korea and Europe, only recently started paying fines in Taiwan, and could be hit by even more fines in the US. It's also premature to assume that it can close the NXP deal or that Apple wants to settle.
The bottom line
For now, Qualcomm's stock is propped up by buyout interest from Broadcom (NASDAQ:AVGO), which made a hostile $70 per share bid for the chipmaker last November. Qualcomm rejected that offer, but Broadcom is reportedly mulling a higher bid.
If Broadcom walks away, Qualcomm's stock could give up most of its recent gains and slide back to the low $50s. The company still faces a gauntlet of fines and legal battles, all of which will dent its revenue and earnings growth over the next few quarters.