Qualcomm (QCOM 1.41%) is prodding regulators across the world to block NVIDIA's (NVDA -3.33%) $40 billion acquisition of the U.K. chip designer Arm Holdings, according to reports from Bloomberg and CNBC.

Qualcomm's opposition to the deal might seem puzzling at first since the two companies sell different types of chips. Qualcomm is the world's largest manufacturer of mobile chipsets for smartphones, while NVIDIA generates most its revenue from GPUs for PC gaming and data centers.

However, a closer look at the relationships between Qualcomm, Arm, and NVIDIA exposes a serious weakness for Qualcomm -- and tells us why it can't afford to let NVIDIA purchase ARM from SoftBank (SFTB.Y 0.93%).

An abstract illustration of electrical circuits.

Image source: Getty Images.

How Qualcomm conquered the mobile market

Qualcomm became the world's largest manufacturer of mobile chips over the past decade for two main reasons. First, it licensed low-power chip designs from Arm, which pushed Intel's less power-efficient x86 mobile chips -- which shared the same architecture as its PC CPUs -- out of the market.

Second, Qualcomm owns the world's largest portfolio of wireless patents, which gives it a cut of every smartphone sold worldwide. It often bundled those licenses with its sales of new chips to OEMs, which made it difficult for other chipmakers to sell their chips at competitive prices.

That's why NVIDIA, Texas Instruments, and other chipmakers stopped selling their own Arm-based chips for smartphones. Today, Qualcomm's main competitors include Taiwan's MediaTek, which stayed in the race by selling lower-end chipsets for emerging markets, along with first-party chips from companies like Apple, Huawei, and Samsung.

Qualcomm's tactics have sparked antitrust complaints from OEMs, which claimed its licensing fees were too high; rival chipmakers, which claimed its bundling strategies were anti-competitive; and government regulators across the world.

How NVIDIA lost the mobile market

Back in 2008, NVIDIA launched its first Arm-based Tegra CPU for the digital media player and smartphone markets. In 2011, it bought the U.K. chipmaker Icera, which produced baseband modems.

NVIDIA's Tegra chips initially powered a few devices, including the Microsoft Kin and Samsung's Galaxy R, but they never gained much traction against Qualcomm.

NVIDIA phased out its baseband modem business in 2015 and abandoned its goal of bunding its chips and modems together to create SoCs (system on chips) to challenge Qualcomm's Snapdragon SoCs.

In 2019, the EU fined Qualcomm for using predatory pricing strategies to drive NVIDIA and other rivals out of the market. But by then, NVIDIA had already pivoted its Tegra chips toward the automotive market and other applications. The Nintendo Switch also notably runs on a Tegra CPU.

A second chance for NVIDIA

Arm doesn't manufacture any chips on its own, it just charges royalties and licensing fees for its low-power designs. Today, NVIDIA and Qualcomm both pay licensing fees to Arm, but NVIDIA doesn't pay any licensing fees to Qualcomm since it no longer produces baseband modems.

After acquiring Arm, NVIDIA will no longer need to pay those licensing fees for its Tegra CPUs. However, Qualcomm will still need to pay Arm licensing fees for its Snapdragon chips.

That shift puts NVIDIA in a strong position to reboot its original mobile plans for Tegra, which accounted for 13% of its sales in fiscal 2020. If NVIDIA starts producing modems again (or purchases them from MediaTek) and bundles them with its Tegra chips in new SoCs for smartphones, it could potentially offset its licensing fees to Qualcomm with its own internal savings from Arm's licensing fees.

NVIDIA could also leverage its ownership of Arm to force Qualcomm to reduce its wireless licensing fees for Tegra-based SoCs. NVIDIA's move could also hurt MediaTek, which already operates at lower gross margins than Qualcomm because it sells lower-end chips and lacks a high-margin licensing business.

Can Qualcomm stop NVIDIA?

Qualcomm is reportedly trying to convince antitrust regulators in the U.S., U.K., Europe, and China to block NVIDIA's purchase of Arm, but it's unclear if they'll halt the deal -- especially since Qualcomm itself was previously accused of anticompetitive moves across all those markets.

However, Microsoft and Alphabet's Google have recently joined Qualcomm in their opposition to the deal. That support could convince regulators to take a closer look at the deal, or force NVIDIA to make some concessions.

For now, NVIDIA has the upper hand, and Qualcomm should be worried. A takeover of Arm could turn the tables on Qualcomm in licensing fees, and potentially pave the way for NVIDIA's return to the mobile market. But it isn't a done deal yet, so investors should simply keep track of the latest developments instead of making any brash headline-driven moves.