July 14, 2011 9:43 pm

Phonemakers await Apple patent case ruling

If the recent slide in HTC’s share price is anything to go by, there is a fair amount of investor nervousness ahead of an initial ruling, expected on Friday, in Apple’s patent infringement lawsuit against the Taiwanese phone maker.

HTC shares tumbled 20 per cent from the middle of last week, before recovering 6.8 per cent on Thursday, as investors took their positions ahead of the decision.

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The ruling will be closely watched because the lawsuit is the first between Apple and smartphone makers that use Google’s Android operating system.

Apple in March last year filed a lawsuit with a US District Court and with the US International Trade Commission, accusing HTC of violating 20 patents relating to the iPhone’s user interface, underlying architecture and hardware. HTC has denied the allegations.

On Friday, the ITC, which has the power to ban the import and sale of goods in the US, is expected to deliver a preliminary ruling on the case.

The decision will provide clues to the possible outcome in separate lawsuits Apple has filed against phone makers Samsung and Motorola – both of which use Android. HTC, Samsung and Motorola have all denied the allegations and have brought countersuits against Apple.

Companies on the losing side of the legal battle face the prospect of having to pay the winner hundreds of millions of dollars a year in royalties, eroding profit margins that are expected to shrink as competition in the sector intensifies.

But analysts say the selldown of HTC’s shares has been overdone. Pauline Chen, a Credit Suisse analyst who upgraded the stock to outperform on Thursday, said the market had gone “from over-bullish to over-bearish” on HTC’s stock.

Ms Chen pointed out that HTC’s recent acquisition of S3 Graphics, the chipmaker which on July 1 won an ITC court ruling against Apple for patent infringement, gave the group “better bargaining power in royalties negotiation” with Apple.

If the decision were to go against HTC, the direct financial impact might not be huge. Morgan Stanley analyst Jasmine Lu writes that even if HTC were to pay Apple $4-$5 per handset sold, that would shave only 1-1.4 per cent off estimated earnings per share of T$91.70 in 2012.

Other analysts, however, caution against trying to predict the outcome of patent cases. It is because of this uncertainty that HTC’s share price has taken a big hit as the ruling nears, says C.K. Cheng, CLSA analyst.

“It’s an uncertainty and the market doesn’t like uncertainties,” he said.

A final ruling from the ITC on the Apple v HTC case is still at least six months away, and Morgan Stanley’s Ms Lu says that “rising litigation uncertainty could remain as a share price overhang” for HTC.

Because Google developed the Android platform – not the phone makers – most handset manufacturers did not bolster patent portfolios in areas such as software and multimedia and are thus vulnerable to legal attack by Apple and Microsoft.

Apple’s settlement with Nokia last month could provide some reference. No financial terms were disclosed, but analysts estimate that Apple agreed to an initial payment to Nokia of $300m-$600m, plus royalty payments that could reach hundreds of millions a year.

HTC last April moved to head off a possible second legal battle by signing a licensing agreement with Microsoft. Under the deal, Citigroup analysts estimate, HTC pays Microsoft $5 for each Google Android phone it sells.

Having to pay royalties means the Android platform is no longer “free” for phone makers, says Mr Cheng.

Google initially distinguished Android by opening it to phone makers with no royalties for its use.

Of even greater concern than royalties for smartphone makers like HTC, Samsung and Motorola is the shadow the legal battles are increasingly casting over the future for Android.

Android-based smartphones dominate global sales, but Apple is expected to launch a new version of the iPhone later this year, and Nokia is poised to re-enter the fray with its first smartphone based on Microsoft’s Windows platform.

While smartphone penetration is still relatively low even in the more mature European and US markets, industry sales growth is expected to slow from 74 per cent last year to 49 per cent this year, according to IDC.

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