Apple (NASDAQ: AAPL) is now contemplating ditching Qualcomm (NASDAQ: QCOM) modems altogether for the 2018 iPhone lineup, according to a pair of reports from Reuters and The Wall Street Journal. That doesn't come as much of a surprise considering how contentious the escalating legal battle between the two companies has become. At issue is certain software that Apple uses to test components, which Qualcomm has reportedly stopped providing to Apple.
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That would suggest an aggressive shift toward Intel (NASDAQ: INTC) models, and Apple might even tap less prominent suppliers like MediaTek for its modem needs. Nothing has been finalized at this early stage, but it appears that Apple is giving the notion some serious consideration. Qualcomm shares are down 7% as of this writing.
Apple has wanted to switch or add suppliers for years
Going back to the original complaint from January 2017, it's clear that Apple has wanted to switch modem suppliers for years. At a minimum, it has always wanted to add additional suppliers, which would reduce supply risk while providing negotiating leverage in securing more favorable volume pricing, which in turn would directly lead to cost savings. Here's what Apple wrote in January (emphasis added):
Although Apple has for many years been ready and able to switch a smaller portion of its baseband processor chipset purchases (e.g., for non-CDMA iPads) to Qualcomm's rivals, Qualcomm's imposition of exclusivity has prevented Apple from switching suppliers on a less than full-line basis, even with non-Qualcomm chipsets priced substantially lower than comparable Qualcomm chipsets.
The company was unable to switch from Qualcomm due to an exclusive supply agreement that expired in 2016.
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Apple could take a big bite out of Qualcomm's top line
Qualcomm's top line has relied heavily on Apple and Samsung as its biggest customers for years, with the two smartphone juggernauts comprising as much as 49% of sales in fiscal year 2014. This figure, which includes licensing revenue as well as chip sales, fell to 45% in fiscal year 2015 and 40% in fiscal year 2016.
In other words, Qualcomm still has quite a bit of exposure to its souring relationship with Apple, and it would take a pretty meaningful hit if Apple made the call to cut Qualcomm modems out.
On a technical level, Apple could conceivably switch to Intel for all of its modem needs in 2018. The Intel modem that powers 2017 iPhones does not support CDMA networks like Verizon and Sprint in the U.S. (those iPhone models still use Qualcomm basebands). Intel's forthcoming XMM 7560 will support CDMA, and while it may still lag Qualcomm's modem performance in certain areas, it should be perfectly sufficient for mainstream consumers.
Intel continues to deepen its relationship with Apple, and Apple's opposition to Qualcomm's business practices is a "principled stand." Beyond gross margin considerations, Apple has plenty of other reasons to make the switch.
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Evan Niu, CFA owns shares of Apple. The Motley Fool owns shares of and recommends Apple and VZ. The Motley Fool owns shares of Qualcomm and has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool recommends Intel. The Motley Fool has a disclosure policy.