Qualcomm to Pressure Apple Via Suppliers

By Evan Niu, CFA Markets Fool.com

The ongoing legal battle between Qualcomm (NASDAQ: QCOM) and Apple (NASDAQ: AAPL) has just escalated yet again.

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The Mac maker recently began withholding royalty payments altogether via its contract manufacturers (CMs), causing Qualcomm to reduce its third-quarter revenue guidance by $500 million. Typically, Apple pays these royalty costs to its suppliers, who then subsequently remit that payment to Qualcomm, since the CMs have direct licensing agreements with Qualcomm. Once Apple stopped paying its suppliers, those suppliers in turn stopped paying Qualcomm. The trouble is that the agreements between CMs and Qualcomm are still valid and enforceable, as Qualcomm noted on its earnings call last month.

Earlier this month, Qualcomm was reportedly exploring an import injunction to block the iPhone, and the latest development is that Qualcomm is now going directly after CMs for what it says it's owed.

Confused yet? Image source: Court filings.

Stuck in the middle with you

The mobile chip giant has filed suit against four prominent Taiwanese CMs, including Foxconn. The company alleges that the CMs are "breaching their license agreements and other commitments with Qualcomm and refusing to pay for use of Qualcomm's licensed technologies." Apple has told its CMs not to pay royalties and has said it will cover the cost of any damages associated with breaching these agreements, according to Qualcomm's complaint, although Apple disputed this characterization in a statement to The Verge.

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The CMs are getting caught in the crossfire in an escalating battle between two of the most powerful tech companies in the smartphone market. It's not all that surprising that it's come to this, as Qualcomm has made it clear that it will explore all legal avenues to collect. Putting pressure on CMs will effectively put more pressure on Apple in turn, since Apple's beef is with Qualcomm and not its CMs. (Although Apple isn't keen on the fact that CMs don't really bother negotiating favorable terms, as Apple foots the bill.)

Qualcomm will probably win these suits

Since the agreements between CMs and Qualcomm are valid and enforceable, irrespective of direct disputes between Apple and Qualcomm, Qualcomm has a good shot of winning these complaints, according to BMO Capital analyst Tim Long. This puts the CMs in a precarious position.

Image source: Apple.

While the CMs collectively have enough cash to pay -- an estimated $25 billion combined -- they have thin operating margins and aren't going to want to essentially spot Apple the cash, particularly as Apple is the richest company on Earth. The CMs could theoretically turn around and file suit against Apple to get the money, but that clearly threatens the relationships that CMs have with one of their largest customers.

Legal battles of this magnitude can be protracted, and there's potentially billions of dollars hanging in the balance until it all gets sorted out.

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Evan Niu, CFA owns shares of Apple. The Motley Fool owns shares of and recommends Apple and Qualcomm. The Motley Fool has a disclosure policy.