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China pressures still weigh on Qualcomm

Qualcomm’s big headaches of 2015 – Chinese licensing disputes and the loss of a key Samsung device deal – continue to drag down its results, even after it has (at least partially) resolved them. And there is little respite ahead, with the company – perhaps the most reliable bellwether for the smartphone industry – warning that growth in handset shipments will continue to slow in 2016.

The mobile chip leader offered a gloomy outlook as it reported lower revenues and profits for its fourth fiscal quarter and full year. As well as the slowing of the smartphone gravy train, it will face even greater pressures on chip prices and margins, especially as low cost Chinese handset makers increase their market share still further.

In fiscal Q4 and full year 2015, Qualcomm was feeling the effects of those trends already, plus the more specific problems of Chinese royalties and the Samsung relationship. The US firm did come to an expensive but essential agreement with the Chinese government over antitrust allegations, which should have restarted the flow of royalty payments from Chinese companies for its patents (many had been withholding fees until they knew the outcome of the investigations into Qualcomm’s business practices).

However, that process has been slow, and the truce with the authorities will squeeze IPR revenues from China anyway – as well as taking the hit of a $975m fine, Qualcomm agreed to charge lower royalty rates on single-technology modems, and to calculate the fees based on 65% of the device’s sale price, which may set a precedent for renegotiation in other markets.

Qualcomm so signed new royalty deals with three large firms – Huawei, TCL and ZTE – but president Derek Aberle, speaking on the earnings call, said there were many more to be concluded, including those with “fewer than a handful” of Chinese OEMs which “in a negotiating tactic have stopped reporting sales and paying royalties”. He does not even expect all these firms to agree terms during 2016. “In the end we will get these agreements concluded, but we are taking a cautious approach because the timing remains uncertain,” he told analysts.

CEO Steve Mollenkopf was more upbeat, saying: “You should read this as just a delay in signing up people, not a change to the overall capability of us to go after that market.” And he stressed that the weakness in the licensing business, which accounts for 60% of operating income, was offset by “higher demand for chipsets than we had thought”.

Chip shipments totaled 203m in the recent quarter, down 14% from a year earlier, but exceeding internal projections – though the additional sales were mainly for midrange and low end handsets, hence the pressure on prices.

The better-than-expected shipments will be a mild relief after the crisis of confidence around Qualcomm’s high end processors earlier this year. The other big blow of 2015 was the loss of a slot for the Snapdragon 810 processor/modem in Samsung’s Galaxy S6 flagship, amid reports of overheating issues.

Qualcomm has managed to claw back business with its second largest customer, and Snapdragon is reportedly due to power many S7 models as well as some midrange smartphones. However, there is a bigger trend at work – for Samsung to rely on its own Exynos mobile chipset for a rising number of its devices, and for OEMs in general to become more self-sufficient in silicon (Huawei has its HiSilicon semiconductor unit, for instance). Apple has its own processors, but still buys modems from Qualcomm, but even this huge deal may have to be shared with Intel from next year.

Overall, Qualcomm predicts that global sales of 3G and 4G handsets will grow next year at a significantly slower rate than in 2015 – which was already seeing weaknesss in the market. The chip giant thinks shipments will rise by 7% to 13%, down from 11% to 17%, which chimes with IDC’s forecast of about 10% growth in 2016. As prices fall, Qualcomm expects even lower growth in revenues, in single-digit percentages.

All these pressures translated into disappointing results for a company whose famous margins once seemed invulnerable. Qualcomm reported revenues down 18% year-on-year to $5.5bn in fiscal Q4, with net income down 44% to $1.1bn. For the full year, sales were down 5% compared to 2014, at $25.3bn, and profit fell 34% to $5.3bn. Net income in the quarter that ends in December will be 80 to 90 cents per share on revenue of $5.2bn to $6bn.

In fact, these results were slightly above the guidance Qualcomm offered in July when it announced a major restructuring program to bring costs in line with the new realities of the smartphone sector. This will involve a 15% reduction in the workforce and the sell-off of non-core activities. The full strategic plan is yet to be finalized and some activist investors are still keen for Qualcomm to break off its licensing business altogether.

There were some signs of light. The company is portraying 2016 as a year of transition, with a return to growth, in both revenue and profit, kicking in towards the end of the fiscal year.

On the analyst call, Aberle said some of the major negative trends were easing, saying: “We expect further declines in average selling prices but probably at half the rate we saw in 2015 for a lot of reasons, including further concentration among China OEMs and more evidence China’s ASPs are increasing to come in line with non-China suppliers – and that will continue.”

Mollenkopf also highlighted 60 “broad-based design wins” for the new Snapdragon 820, which was recently unveiled. The 820 is a major fightback by Qualcomm and proof that its engineering and IPR prowess still enables it to set new bars in terms of performance and functionality. Its big challenge now is to marry that cutting edge capability with sufficiently keen pricing to take on MediaTek, Spreadtrum and other rising stars from Greater China.

Mollenkopf also pointed to closer ties with Samsung after the S6 disaster, saying the relationship was “getting stronger versus moving the other direction”, especially as Qualcomm is now using the Korean firm as one of its foundries.

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