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Qualcomm Inks Critical Licensing Deal with China’s Xiaomi

December 2, 2015, 8:46 PM UTC
UNICORN 2015 — Lei Jun Xiaomi
Photograph by ChinaFotoPress via Getty Images

Qualcomm is one step closer to handling its licensing troubles in China.

Xiaomi, the second-largest China-based smartphone vendor, and one of the biggest handset makers in the world, has agreed to pay Qualcomm (QCOM) a royalty on devices it sells that can connect to 3G and 4G cellular networks, the companies announced on Wednesday. The companies did not disclose the terms of the deal.

Qualcomm is one of the world’s foremost licensees of patents related to cellular technology. According to analysts, the company has 170 patents related to long-term evolution (LTE) cellular technology alone, and in its last fiscal year, generated $8.2 billion on patent royalties for cellular communication. That figure was up from $7.9 billion in the previous year.

Ownership of the basic methods that chips inside mobile devices use to connect to cellular networks are a critical piece of Qualcomm’s patent portfolio. If a device can connect to a cellular network on just about any mobile phone service around the world, a small royalty is technically required to be paid to Qualcomm for that right.

These patents are so valuable that earlier this year, Jana Partners LLC, which acquired more than $2 billion in Qualcomm shares, called on the company to restructure its operation and even consider breaking out its licensing business. The issue, analysts and investors say, is that while Qualcomm generates about two-thirds of its revenue from the production of processors running in smartphones and tablets (among other products) approximately two-thirds of the company’s profit comes from its patent licensing.

Qualcomm’s non-licensing revenue hit $17 billion in its last fiscal year, which ended Sept. 27, down from the $18.6 billion it generated in the prior year. Overall, Qualcomm’s profits slipped from $8 billion to $5.3 billion, year-over-year.

While those figures were enough to raise concerns among investors, China was also a major focal point last month, when Qualcomm announced its earnings. The company acknowledged that it has faced headwinds in China attempting to license its patents to device-makers. That market, which ships hundreds of millions of smartphones each year, had largely ignored Qualcomm’s demands for patent licensing.

Meanwhile, the Chinese government has also proven difficult to work with. In Feb., Qualcomm announced that it had settled a nasty dispute with Chinese antitrust authorities over its licensing policies. The company was forced to pay a $975 million fine and change how it licenses patents for phones sold across China.

Qualcomm said that it was displeased with the findings, but would pay the fine. Perhaps more importantly, the agreement allowed Qualcomm to actively seek out licenses with Chinese device makers, albeit under the rules outlined by the country’s antitrust commission.

Since then, Qualcomm has been working to allay investor fears that China, the world’s largest smartphone market, wasn’t generating enough revenue for the company.

In November, the company acknowledged its issues in China during an earnings call, saying that it had secured more than 60 licenses there. Still, some of the country’s biggest competitors, including Xiaomi, were notably absent from that list. The company said that it was frustrated by how long it was taking to ink deals with manufacturers, but added that it was confident it could sign agreements.

The agreement with Xiaomi is a major step in proving that point. Xiaomi is one of the world’s largest smartphone makers and the second-largest in China behind Huawei. Xiaomi has set a goal of shipping 100 million smartphones worldwide this year. That figure does not include tablets, which could also be part of the deal with Qualcomm.

In February, Qualcomm said that it would charge royalties of up to 5% on smartphones sold in China. Those royalties would be based on 65% of the respective device’s retail price. Using those figures, it’s possible Qualcomm could generate significant revenue from the sale of Xiaomi devices for years to come.

Shareholders haven’t lost sight of that possibility. In trading on Wednesday, Qualcomm’s shares are up 7.4% to $52.96 in response to the Xiaomi deal. The jump stands in stark contrast to the troubles Qualcomm’s stock has faced this year overall—it’s down nearly 29% since January.

Still, it’s unclear what the future holds for Qualcomm in China. Xiaomi may have been an easier target for Qualcomm, since the company’s investment arm, Qualcomm Ventures, owns a stake in the China-based device maker. The company has confirmed Huawei, China’s largest smartphone maker and arguably the most important partner for Qualcomm to land in China, has signed the terms of the February agreement. Qualcomm did not comment on whether Huawei is paying licenses to Qualcomm. The company is expected to ship more than 110 million smartphones this year, alone.

Qualcomm did not respond to a request for comment.

For more on Xiaomi, check out the following Fortune video:

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Update: This story was corrected Dec. 2 to reflect that Huawei does have an agreement with Qualcomm.