Why Apple's Siri Patent-Infringement Trial Can Impact Its Future

Jul.10.14 | About: Apple Inc. (AAPL)

Summary

Zhizhen's patents claims are hard to dispute given that the company's "Xiao i Robot" software was patented in 2004.

Not only does Zhizhen make voice-activated software for iOS and Android, the company claims to have more than 100 million people using the software in a wide range of industries.

If Apple gets bold and loses, the winners in all of this would be its rivals Google and Samsung.

Apple (NASDAQ:AAPL) lost an important battle Wednesday in its fight to secure its ownership of Siri, its personal assistant feature comes with its iPhones. The fate of the popular voice-controlled application will be determined through litigation.

A Beijing court has ruled in favor of Shanghai-based Zhizhen Network Technology, which filed the original suit back in 2012 has long argued that they were the rightful owners of the speech-recognition patent. Contesting claims made by both Zhizhen and the State Intellectual Property Office, Apple has argued against the validity of the patent.

Despite this recent setback, investors shrugged the news. Apple stock ended Wednesday's session at $95.39, up 4 cents. Shares are up 21% on the year to date, including 30% gains since April.

Responding to an email sent by The Register, Apple representatives claimed they were unaware of Zhizhen's patent before Apple Siri was introduced, adding "we do not believe we are using this patent." The courts, on the other hand, has seen enough to suggests it's worth a trial.

While this is only the first leg in what is likely to be a long-standing battle, the potential impact to Apple should not be taken lightly. Not to mention, Zhizhen's patents claims are hard to dispute given that the company's "Xiao i Robot" software was patented in 2004. This makes it tough for Apple to dispute patent priority.

Recall, Siri made its debut in 2007. Wanting an early entry into mobile search against Google (NASDAQ:GOOG) (NASDAQ:GOOGL), Apple bought Siri three years later. Although the terms of the deal was never disclosed, various industry experts believe Apple paid anywhere from $100 million to $200 million.

At the time of the deal, Siri's investors had only raised $24 million. They've gotten paid handsomely. Now Zhizhen believes it's their turn. And they've got a strong case.

Not only does Zhizhen make voice-activated software for iOS and Android, the company claims to have more than 100 million people using the software in a wide range of industries, predating the existence of the iPhone. Of course, this does little to prove whether Apple has violated on any patents. That's for the courts to determine.

With the iPhone accounting for close to 60% of Apple's total revenue, it can't afford to lose this case. At the risk of an overstatement, the potential impact to Apple's global sales would be catastrophic.

Losing this battle to Zhizhen will likely come with a cease and decease order, blocking Siri-enabled iPhones from being sold. The other option would be for Apple to consider removing Siri off of the phones already out in the market. Aside from the potential loss of revenue, Apple would incur significant costs to execute the latter.

In either scenario, I suspect Apple would also be liable for potential revenue losses to Zhizhen. Given Apple generates more than $10 billion in profits per quarters, Zhizhen, which doesn't disclose its annual sales, would command a figure that surpasses the original (speculated upon) purchase amount for Siri.

It's possible that this case can also be settled before it gets even more serious. While also responding to The Register, Apple said, "we remain open to reasonable discussions with Zhizhen."

This, in my opinion, is the outcome investors should want. If Apple gets bold and loses, the winners in all of this would be its rivals Google and Samsung (OTC:SSNLF). Siri is projected to be an important part of the iWatch and Apple's entry into the world of the automated smart-home.

Samsung, on the other hand, remains stuck in low-margin hardware. The mobile phone market is suffering from high-end device saturation and low average selling prices. Google would exploit an opening to dominate voice automation before it even begins.

All told, with over $150 billion in cash on the balance sheet, there are few things Apple can't afford. Losing Siri just shot up to the top of that list.

Disclosure: The author is long AAPL.

Business relationship disclosure: The article has been written by Wall Street Playbook's tech sector analyst. Wall Street Playbook is not receiving compensation for it (other than from Seeking Alpha). Wall Street Playbook has no business relationship with any company whose stock is mentioned in this article.

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