Short Seller Takes Aim at Qualcomm

Leading with the statement that Qualcomm Inc. (NASDAQ: QCOM) is “teetering on the brink of disaster,” Kerrisdale Capital Management said Wednesday it and its affiliates have taken short positions in the chipmaker. Qualcomm is currently embroiled in a lawsuit brought by the U.S. Federal Trade Commission (FTC) for what the agency alleges are violations of binding pledges the company has made to license critical patents on what are known in the industry as “fair, reasonable, and non-discriminatory” (FRAND) terms.

Kerrisdale believes that the FTC is not seeking merely a fine against the company, “it’s looking to fundamentally change how the company does business” by forcing Qualcomm to license its most important patents on FRAND terms to competitors like Intel. In practice, that means that Qualcomm’s royalties would be set at a small percentage of the price of a modem chip rather than Qualcomm’s long-standing practice of charging device-makers a high percentage of the price of an entire phone in addition to the chip price.

According to Kerrisdale, under Qualcomm’s current pricing the company sells its chips for a fixed amount, say $20, and charges phonemakers a license fee that could be as high an additional $20, a royalty payment that Apple has called “extortion-level.”

If Qualcomm loses in the FTC case, it would be a big problem for the company’s revenue and profit streams. Assume that Intel also sells a modem chip for $20 plus a modest FRAND fee of $1.50 to a phonemaker. Under patent law, Qualcomm could no longer charge the additional $20 smartphone license fee. Royalty payments would drop from $40 to $21 per modem.

Kerrisdale estimates that resetting Qualcomm’s licensing revenue to these levels will slash revenue by $2.7 billion and reduce operating diluted earnings to $1.64 per share, implying a fair-value stock price of about $21 based on historical Qualcomm and peer multiples. That’s more than 60% lower than Qualcomm’s current share price.

Federal District Court Judge Lucy Koh already has dismissed Qualcomm’s motion to dismiss the FTC lawsuit, and in a different consumer class-action based on similar charges, she characterized the evidence presented in that case as showing “anticompetitive practices [that] harmed consumers as ‘copious,’ ‘substantial,’ and ‘significant'” according to Kerrisdale.

Perhaps the most damaging part of Kerrisdale’s announcement is a calculation the firm runs based on testimony from an FTC expert witness who said that all standards-essential patents (SEPs) should receive a total combined royalty rate of about 6% and that Qualcomm’s share was just 10% of that amount. That’s a new royalty rate for the modem chip of just $0.12 per phone, essentially zero compared to whatever Qualcomm now realizes from its smartphone license fee (Kerrisdale estimates that at between $10 and $20 per phone).

Qualcomm’s share price has dropped about 4.2% Wednesday to around $52.00, in a 52-week range of $48.56 to $76.50.

The consensus 12-month price target on the stock is $67.60. If Kerrisdale’s calculations are accurate, the price target on the stock should be around $21. Stay tuned.

Kerrisdale’s full announcement is available at the firm’s website.