How Intel Corporation Can Strengthen Its Relationship With Apple Inc.

By Ashraf Eassa Markets Fool.com

With the Apple (NASDAQ: AAPL) iPhone 7, microprocessor giant Intel (NASDAQ: INTC) scored a lucky break, winning a significant portion of the cellular modem orders for Apple's latest handsets -- arguably the highest-profile smartphone win that Intel has ever enjoyed.

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Image source: Apple.

Intel cellular modem chips, branded the XMM 7360, are found inside versions of the iPhone 7 devices used on networks that don't implement the CDMA cellular standard. Chips from rival Qualcomm (NASDAQ: QCOM) are found in the iPhone models used on CDMA networks, as Intel's chips currently don't implement CDMA.

Back in late 2015, Intel purchased the CDMA chipset assets from a company called VIA Telecom, presumably in a bid to allow the former to build chips that could address the entirety of Apple's cellular modem needs.

Though Qualcomm is widely believed to build superior modems to what Intel produces, Apple recently filed a lawsuit against Qualcomm alleging, among other things, that "Qualcomm has charged Apple a monopolistic premium for access to CDMA chipsets that are in all other aspects identical to chipsets sold to Apple without CDMA functionality enabled. ... Qualcomm has used its monopoly power in CDMA chipsets to obtain anticompetitive license and chipset supply terms," the complaint filed on Jan. 20 read.

I'll be writing more on the lawsuit in the coming days and today there is an observation I would like to share regarding Apple, Intel, Qualcomm, and CDMA iPhones.

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Apple's component costs could come down if Intel succeeds in implementing CDMA

Based on this complaint, we now know that Qualcomm charges Apple more for the same exact cellular modems with CDMA enabled compared to versions without CDMA enabled. This isn't an unusual practice in the semiconductor industry; companies like Intel routinely charge more for identical chips but with certain features enabled, compared with variants without those features enabled. This is plain old product segmentation at work.

Image source: Qualcomm.

What's interesting is that Apple is complaining that, because Qualcomm essentially has no viable competition for its CDMA-enabled modems, it is charging a "monopolistic premium."

The magnitude of this premium isn't clear, but it's clear that Apple isn't happy about having to pay it, and therein lies the opportunity for Intel.

If Intel can develop a commercially viable LTE modem that also supports CDMA (and is certified on all of the major CDMA networks) using those VIA Telecom assets, then this would open the door to a couple of possibilities:

  1. Intel could win more than just the non-CDMA iPhones. It could be a true "second source" for all the iPhones that Apple ships. This could potentially boost Intel's share at Apple, to Intel's benefit (and to Qualcomm's detriment).
  2. Apple could be able to get cheaper CDMA modems from Qualcomm. Even if Apple doesn't increase the proportion of total modems that it purchases from Intel, the fact that Intel and Qualcomm parts would be viable for all iPhone models could help reduce the average price that Apple pays per cellular modem.

Net-net, Intel's becoming a stronger cellular modem provider would mean that Apple should, in general, pay less for modems. This could help modestly improve Apple's gross profit margin and, ultimately, net profit.

To put this into perspective, in the complaint, Apple says that LTE modems sell for between $10 and $20. Let's suppose that Apple must pay $15 for the non-CDMA Qualcomm chips and then $20 for the CDMA-capable Qualcomm chips -- though with the iPhone 7, Apple doesn't appear to be buying any non-CDMA Qualcomm chips; the non-CDMA iPhones now use Intel.

If Apple can get that $20 figure down to $15 in the presence of a viable alternative from Intel, then that's $5 saved across potentially 100 million or more iPhone models sold in a year. That $5 figure is for illustrative purposes only, as I have no clue what the actual delta is, but multiplied across the volumes that Apple sells, the savings Apple could potentially realize are significant.

Intel needs to execute

The key to all of this is for Intel to execute to building increasingly competitive cellular modems. If Intel can, then that's obviously a positive for Intel, as an opportunity to sell more modems, and an opportunity for Apple, in the form of cheaper modems.

The loser, if Intel can supply more of Apple's volume -- whether or not it actually does -- would be Qualcomm, as at the very least it could see the premium that it enjoys from the sale of CDMA-capable LTE modems evaporate.

In the scheme of things, though, losing a bit more Apple chip business probably isn't going to sting Qualcomm that much. After all, Intel grabbed a bunch of iPhone share this cycle, yet Qualcomm's chip business appears to be on the right track.

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Ashraf Eassa owns shares of Intel and Qualcomm. The Motley Fool owns shares of and recommends Apple 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 Intel. The Motley Fool has a disclosure policy.