Is This What's Held Back Apple, Inc.'s Cellular Baseband Ambitions?

By Evan Niu, CFA Markets Fool.com

You won't find an integrated baseband in the A10 Fusion chip. Image source: Apple.

Continue Reading Below

"There is no stand-alone modem business anymore."

That's NVIDIA CEO Jen-Hsun Huang from a conference call way back in 2013, when the company was developing a Tegra mobile processor with an integrated baseband modem to challenge Qualcomm (NASDAQ: QCOM). The baseband market had been shifting toward integrated solutions for years, and Qualcomm was by far the technological leader with integrated cellular connectivity. Integration provides significant benefits in costs and power efficiency relative to stand-alone modems.

Yet, here we are in 2017 and Apple (NASDAQ: AAPL) is still using stand-alone baseband modems. The Mac maker had been exclusively sourcing modems from Qualcomm for about five years, and only recently added Intel to the mix as a second supplier. But over the years as Apple's own chip ambitions grew with its A-chips, this question has lingered: Why hasn't Apple integrated cellular connectivity into A-chips? We know the company places high value on power efficiency, which directly affects battery life.

The answer may potentially lie in the FTC's recent anticompetitive complaint (link opens PDF) against Qualcomm.

[Redacted] = Apple?

Continue Reading Below

While the complaint has an entire section dedicated to Qualcomm's relationship with Apple, and all the ways Qualcomm leveraged its baseband supplier relationship to score exclusivity, the second charge is that Qualcomm consistently refused to license its standards-essential patents (SEPs) to competitors at fair, reasonable, and non-discriminatory (FRAND) rates, contrary to its commitments.

For smartphone OEMs that it supplies basebands to, Qualcomm has incredible leverage since any disruption in baseband supply could cripple their ability to make mobile devices. But for competing suppliers where Qualcomm lacks that leverage, licensing SEPs enables competition. Things get a little murkier when you talk about vertically integrated companies that are both customers and competitors. Samsung comes to mind as a prominent customer of Qualcomm chips as well as a maker of applications processors and baseband processors.

Apple has long been a customer, and common sense suggests it should also have been interested in licensing Qualcomm's SEPs in order to integrate cellular connectivity into its own chips. Over the years, there's been tons of evidence that Apple isbuilding its own wireless chips.

Naturally, Qualcomm wouldn't want to lose Apple's baseband business; did Qualcomm refuse to license its SEPs to the iPhone maker? What if Apple is the redacted company from this part of the complaint?

In breach of its FRAND commitments, at odds with its recognition that other industry participants "will require" a license to its FRAND-encumbered SEPs, and in tension with its practice of securing patent licenses for the benefit of its own customers, Qualcomm has consistently refused to license its SEPs to competing suppliers of baseband processors. Several of Qualcomm's former and current competitors, including Intel, [redacted], and Samsung, have sought SEP licenses from Qualcomm. In each instance, Qualcomm refused to grant a SEP license.

You might not consider Apple a competitor to Qualcomm, but it very much is, particularly as its chip engineering teams have ballooned in recent years. Apple designs many competing semiconductors, even if it doesn't sell them to other companies and just uses them in its own products. Qualcomm competes for Apple's business against Apple's own chip teams.

Refusing to license SEPs to Apple could be the perfect answer to the question that's been bothering me for years, since that would easily explain why Apple has yet to integrate cellular connectivity. Apple simply can't risk losing access to Qualcomm's modems, since the iPhone accounts for two-thirds of sales.

And it's not as if Apple could quickly ditch Qualcomm basebands in favor of its own A-chips with integrated cellular connectivity; it would take years for Apple to design and develop even after scoring a SEP license and it would need basebands in the interim. That's not a transition that Qualcomm would be supportive of, as granting Apple a SEP license would merely lay the foundation for Apple eventually ditching Qualcomm's basebands.

As a result, Apple has quietly endured Qualcomm's demands for the past five years.

10 stocks we like better than Apple
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Apple wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of January 4, 2017

Evan Niu, CFA owns shares of Apple. The Motley Fool owns shares of and recommends Apple, NVIDIA, and Qualcomm. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. The Motley Fool recommends INTC. The Motley Fool has a disclosure policy.