ARM Holdings and Qualcomm have a tough relationship. They both benefit from each other’s business, yet have been embroiled in a two-year-long legal battle over intellectual property rights. The two companies will meet in court this week and the semiconductor industry will be monitoring the developments closely.
Here’s what the issue is. Qualcomm acquired a startup called Nuvia in 2022 for $1.4 billion. The move made little sense for the chipmaker, except for one small point. Nuvia was a license holder of ARM’s technology. While Nuvia’s license was not transferable, Qualcomm continued to use it without getting ARM’s approval first. This has started a controversy that has dragged down both companies in the last 6 months. QCOM is down 29% during this period while ARM went down as much as 50% at its lowest point in August.
The crux of the matter is that ARM has sent a cancellation notice of its licensing deal to Qualcomm. This deadline is set to expire next week. The trial is expected to end before that deadline.
Even though this looks like a heated battle, things can improve for both companies simultaneously. ARM generates 11% of its total revenue from QCOM. The company is at a point where its growth is stagnating, with just 5% YoY growth reported in the last quarter. This comes at a time when chip companies are booming. If the licensing deal gets canceled, ARM stands to lose 11% of its top line, which will be a massive blow.
Qualcomm on the other hand has its technology at stake, not just revenue. The company used Nuvia’s ARM license to design its chips for the AI laptops it sells. The Snapdragon chip for smartphones is also built on the same designs. A cancelation of the licensing deal will mean it cannot make the Snapdragon chips anymore(or continue to make them at a bigger cost till things are worked out between the two).
The best outcome for ARM is to not win the case and cancel the license but to win the case and then re-negotiate a better deal that helps it generate more revenue.
For QCOM, the best-case scenario is to continue using ARM’s custom technology. If this comes at a greater cost, so be it. If investors are worried about the cost, they may find some relief in QCOM’s diversification plans. The company will continue to make investments to diversify its design sources. One can question their ability to scale these alternative sources, but it cannot be denied that with time, QCOM can easily diversify away from its reliance on ARM. This also poses a big risk for ARM, which is why we believe a settlement is likely soon.
Let’s also not forget that Donald Trump is about to take office. Trump was in office when QCOM and Apple settled their longstanding dispute in 2019. Back then, Trump wanted chip companies to get their act together and unify against China. This time around, the situation is similar, except AI is added to the mix. Trump would never want one of America’s biggest chipmakers to be embroiled in a legal battle due to its AI chips, which is why we think a bullish settlement for QCOM is on the cards.
QCOM is not on our latest list of the 31 Most Popular Stocks Among Hedge Funds. As per our database, 74 hedge fund portfolios held QCOM at the end of the third quarter which was 100 in the previous quarter. While we acknowledge the potential of QCOM as a leading investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns, and doing so within a shorter timeframe. If you are looking for an AI stock that is as promising as QCOM but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
READ NEXT: $30 Trillion Opportunity: 15 Best Humanoid Robot Stocks to Buy According to Morgan Stanley and Jim Cramer Says NVIDIA ‘Has Become A Wasteland’.
Disclosure: None. This article was originally published at Insider Monkey.
Hedge Fund Resource Center