This is a quick follow on/expansion/correction (whatever you want to call it) to a recent article I wrote on Qualcomm (QCOM) titled, "Qualcomm Is Doing Great." In particular, I believe that while my article conveyed the spirit/main thrust of the idea that I was trying to convey (that most of Qualcomm's profitability comes from collecting royalties for its wireless patents), I was a bit loose with the details. In this piece, I'd like to be more specific.
How Does Qualcomm Generate Its Royalties?
In the aforementioned article, I made the following claim,
In the chart above, note that "QCT" represents "Qualcomm Communication Technologies" or essentially modems and apps processors (among other things such as connectivity). "QTL" represents the company's technology licensing arm - in essence, the company has a boatload of fundamental wireless technology patents and enforces them quite well. For each 3G and 4G/LTE device sold, Qualcomm sees royalties of somewhere between 3.25% and 5%. That's of the selling price of the device. Yes, so for each $650+ iPhone sale, Qualcomm not only gets paid the modem/RF content (~$30/piece) but it gets to collect a nice check to the tune of $33+ per unit sold. I don't know about you, but has got to be one of the best business models I've ever seen.
While I was indeed correct about the royalty rate and the general business model, somebody recently made the claim in the comments section of a recent piece that Qualcomm doesn't collect royalties based on the final selling price but rather the selling price of the phone to the handset vendor from the manufacturer (i.e. the likes of Foxconn).
Now, keep in mind that in Qualcomm's Form 10-K, the company makes the following statement,
QTL licensing revenues are comprised of license fees as well as royalties based on worldwide sales by licensees of products incorporating or using our intellectual property. License fees are fixed amounts paid in one or more installments. Royalties are generally based upon a percentage of the wholesale (i.e., licensee's) selling price of complete licensed products, net of certain permissible deductions (e.g., certain shipping costs, packing costs, VAT, etc.)
So, OK, it would initially seem to me that Apple (AAPL) would be such a licensee since it designed and sold its own handsets. However, some quick-and-dirty math tends to suggest that something else would be at play here. Indeed, looking at Apple's results for FY2013, it sold about 150 million iPhones during the year. Assuming an average selling price of $580 per phone (I've seen this number and others, so PLEASE assume that this is a good BALLPARK number), a 3.25 - 5% royalty rate on the SELLING PRICE would suggest royalties in the range of $2.8B per year just from Apple.
Now, given that QTL's (Qualcomm Technology Licensing) entire revenue base was $7.5B during the year, I find it difficult to believe that Apple - with roughly 13% of the smartphone market - comprised 37% of Qualcomm's royalty base. Further, digging deeper into the 10-K looking for >= 10% customers, I found the following,
A small number of customers/licensees historically have accounted for a significant portion of our consolidated revenues. In fiscal 2013 , 2012 and 2011 , revenues from Samsung Electronics constituted more than 10% of consolidated revenues; in fiscal 2013 and 2012, revenues from Hon Hai Precision Industry Co., Ltd./Foxconn, its affiliates and other suppliers to Apple Inc. constituted more than 10% of consolidated revenues; and in fiscal 2011 , revenues from HTC constituted more than 10% of consolidated revenues.
Note that Apple itself isn't named as the 10% customer but instead Apple's manufacturing partners. This lends credence to the notion that Apple (and Qualcomm's other licensees) are paying royalties based on manufacturing cost rather than end-user sales. However, this notion is again betrayed by statements that Qualcomm's management made at its recent analyst day. In particular,
We also have talked about it and I'll cover this in the next slide here. We do have, what we have referred to as royalty caps in the program as well as minimum royalty. So, on the complete device when we license the complete device like a smartphone or a tablet or phablet, again it's -- the royalty structure is generally a percentage of the selling price. But kind of from the inception of the program, we've had these royalty caps in place which really were designed to kind of cap the royalty on the sort of the highest price devices that we would see, cellular technology going into.
Hm. So, what seems to be going on here is that the royalty is charged to whoever actually manufactures the device. Since Samsung (OTC:SSNLF) builds its own devices, it pays the royalty rate on the finished product, but since Apple "buys" its phones from third parties, those third parties are the ones paying up. Further, if you'll notice in the previous snippet from analyst day, Qualcomm mentions a "royalty cap" which basically means that even as selling prices for a given device go up, the royalty can't go beyond a certain point:
So, How Much Is Qualcomm Really Getting Per iPhone?
Well, Qualcomm collects the following from the iPhone:
- The selling price of its cellular baseband
- The selling price of its RF Transceiver
The actual "chip" content is probably more in the realm of $20/unit (depending on how aggressive Qualcomm is on pricing to Apple). As far as royalties go, it's really hard to get a read, but assuming that the top shelf iPhone has a BoM of $199 and assuming Foxconn et. al. mark it up $50 (20% GM) on top of the production costs, and assuming that the royalties are probably near the high end of the range (since, frankly, Apple isn't going to get off easy thanks to the structure here), we can probably assume royalties of $12.50 per device.
$12.50 * 150 million = $1.87B per year from Apple. A bit lower than my initial estimate, but still a sizable chunk of QTL's revenue base nonetheless.
On top of that, $20/unit for the modems (this is overstating it a bit in the case of the legacy iPhone 4s, but this is good ballpark) suggests $3 billion in sales for QCT. All put together, Apple is one of Qualcomm's best source of revenues and profits.
So, Qualcomm is still very highly levered to Apple's success, but I did overstate the actual impact by a fair amount in my last article. I hope that this piece serves to "correct" that, and I look forward to your (my readers') thoughts on the assumptions/estimates made here.