Why the Future is Expanding For Wireless IP Companies
In the days of yore, people picked up a telephone (you remember actually talking over the telephone?) and simply made a call by entering a phone number on the touchtone pad and voila -- a telephonic connection began. With the development of the first mobile networks and phones, phone calling became portable, and basic texting emerged (anyone else remember texting using the "T9" approach?).
As mobile technologies and computing powered evolved, and their costs curves matured as the cost of transmission and storage of data continually fell, mobile phones gained new capabilities which in turn spurred demand for more advanced capabilities and services. In July 2008 Apple (AAPL) debuted its 3G iPhone and the iPhone App Store, and it’s fair to say we haven’t looked back as these devices and apps have increasingly become an integral part of our daily lives as we text, video chat, shop, send pictures, bank, and just about any/everything else.
5G will not only expand the market for RF semiconductor companies, but it will open up new markets for companies seeking to monetize their wireless IP patent portfolio.
Science fiction author Arthur C. Clarke is often quoted as saying "Any sufficiently advanced technology is indistinguishable from magic." To make all the "magic" of modern telecommunication a reality requires not only mobile networks and devices but also all of the chips that make them work and provide connectivity. Underneath it all, companies have made enormous investments in developing and manufacturing core wireless communications technologies and when we dig deep enough, we find that at the heart of this mobile disruption is a series of technological innovations in wireless technology standards.
It’s these protocols that allow for networks and devices to function as firms can only develop standards-compliant products. Products incorporating these wireless standards include mobile devices, such as cellular phones, tablets, notebook computers, and wireless personal digital assistants; wireless infrastructure equipment, such as base stations; components, dongles and modules for wireless devices; and Internet of Things (IoT) devices and software platforms.
Because of the nature of how these wireless standards are developed, not to mention the market opportunity to be had, a wide variety of companies both collaborate and compete with one another to develop these common wireless technology standards. Arguably the holy grail in developing new wireless technology standards, such as 4G LTE or now 5G and eventually 6G, is for a firm to develop “essential patents” that are core to the technology. As mobile operators and device companies build out networks and devices, the value tied to those essential patents increases.
Some companies develop these technologies for in-house use, while some look to license their intellectual property to others so as to monetize their investment, and there are others that look to do both. Examples of such companies run the gamut from Qualcomm (QCOM), InterDigital (IDCC), and Nokia (NOK), while others either through internal development or the acquisition of IP include Samsung (OO5930:KS), LG Electronics (066570:KS), Apple, Alphabet (GOOGL), Ericsson (ERIC), Alcatel Lucent, Huawei, ZTE Corp. (000063:CH), and Intel (INTC) among others. Those, such as Qualcomm, InterDigital, and others that look to monetize their patent portfolio strive to enter license agreements, primarily with device manufacturers on a variable royalty basis, while others are structured on a fixed-fee basis or a combination between the two.
As the most recent InterDigital 10-K spells out, a fixed fee agreement “can include paid-up licenses for a period of time, for a class of products, for a number of products sold, under certain patents or patent claims, for sales in certain countries or a combination thereof. Licenses become paid-up based on the payment of fixed amounts or after the payment of royalties for a term.”
A variable agreement depends on the sales of products incorporating or using a company’s licensed intellectual property with such royalties generally based upon a percentage of the wholesale selling price. Some, such as Qualcomm, provide per-unit royalty caps that apply to certain categories of complete wireless devices, namely smartphones, tablets, laptops, and smartwatches, and provide for a maximum royalty amount payable per device.
From an investor perspective, this IP licensing business model is not very capital intensive but is highly lucrative given the substantial margins associated with it. For example, the operating margins associated with Qualcomm’s licensing business ranged from 64% to 80% over the 2017-2019 period, comprising more than half of the company’s overall operating profit during that period. In the first half of this year, Nokia’s Nokia Technologies operating margin was 83%, flat with the same period of 2019, and the business generated 64% of Nokia’s operating profit for the first six months of 2020.
As a result, we’ve seen IP licensors look to expand their IP war chest through acquisitions, while in some cases licensees have are looking to shore up their IP position and minimize the licensing fees they are paying. Perhaps the greatest example of the latter was had in 2011 when a consortium Apple, BlackBerry (BB), Microsoft (MSFT), Ericsson, Sony (SNE), and EMC, which is now owned by Dell Technologies (DELL), agreed to buy more than 6,000 patents covering key telecommunications technologies, from Internet services to wireless data networking from bankrupt Nortel Corp. for $4.5 billion.
Here’s the thing, 5G mobile technology is poised to dramatically expand the addressable market for mobile technology beyond its primary volume market that is smartphones. Some examples include connected vehicles (telematics, in-vehicle entertainment, semi-and autonomous driving), smart grid management, public video surveillance and security, VR and cloud gaming, and other industrial applications. This in turn opens up new markets for wireless IP licensing business models and augments existing revenue streams for wireless IP licensors.
As one might expect, one of the hurdles, particularly as these new markets go online, is the negotiation process between the IP licensor and prospective licensees that may be utilizing the licensors technologies and patents. In some cases, negotiations may be straightforward, while in others they can become quite contentious and lead to litigation.
For example, in 2018 Broadcom (AVGO) settled out of court with Volkswagen AG (VLKAY), ending a billion-dollar patent lawsuit that centered on 18 of Broadcom’s patents that Volkswagen used in the navigation and entertainment systems for several of its car models.
More recently Nokia, won a court ruling in a patent dispute with Daimler AG (DDAIF), with the court ruling in favor of Nokia because Daimler wasn’t willing to abide by existing rule for so-called essential patents. We agree that the court’s ruling goes to the heart of how technology must be licensed for mobile-telecommunication systems that are standard features in most modern cars. We also suspect Daimler will likely appeal, and that ultimately some deal between the two companies will be struck.
Given the implications for not only incremental revenue streams for the IP licensor but also at least a nudge higher in costs for the licensee, investors should continue to follow these and other wireless IP licensing developments, particularly since the impact is likely to ripple across the growing array of connected devices affecting margins for licensors and licensees. In our experience, expanding addressable markets and rich margins tend to drive improving revenue, earnings cash flow and stock prices.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Chris Versace
Christopher (Chris) Versace is the Chief Investment Officer and thematic strategist at Tematica Research. The proprietary thematic investing framework that he’s developed over the last decade leverages changing economic, demographic, psychographic and technology landscapes to identify pronounced, multi-year structural changes. This framework sits at the heart of Tematica’s investment themes and indices and builds on his more than 25 years analyzing industries, companies and their business models as well as financial statements. Versace is the co-author of “Cocktail Investing: Distilling Everyday Noise into Clear Investing Signals” and hosts the Thematic Signals podcast. He is also an Assistant Professor at NJCU School of Business, where he developed the NJCU New Jersey 50 Index.
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Lenore Elle Hawkins
Lenore Elle Hawkins has, for over a decade, served as a founding partner of Calit Advisors, a boutique advisory firm specializing in mergers and acquisitions, private capital raise, and corporate finance with offices in Italy, Ireland, and California. She has previously served as the Chief Macro Strategist for Tematica Research, which primarily develops indices for Exchange Traded Products, co-authored the book Cocktail Investing, and is a regular guest on a variety of national and international investing-oriented television programs. She holds a degree in Mathematics and Economics from Claremont McKenna College, an MBA in Finance from the Anderson School at UCLA and is a member of the Mont Pelerin Society.
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Mark Abssy
Mark Abssy is Head of Indexing at Tematica Research focused on index and Exchange Traded Product development. He has product development and management experience with Indexes, ETFs, ETNs, Mutual Funds and listed derivatives. In his 25 year career he has held product development and management positions at NYSE|ICE, ISE ETF Ventures, Morgan Stanley, Fidelity Investments and Loomis Sayles. He received a BSBA from Northeastern University with a focus in Finance and International Business.
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