Qualcomm said China presents 'significant challenges'

The Chinese mobile market is a cornerstone of Qualcomm's future.

And right now, the Chinese smartphone market holds out huge potential rewards, and some serious risks, as well.

Qualcomm is well-positioned to generate a lot of money in China, because of growing demand from the burgeoning class of Chinese consumers with smartphones.

Attendees mingle in the Qualcomm booth at the International Consumer Electronics Show in Las Vegas.
Daniel Acker | Bloomberg | Getty Images

But in Qualcomm's last earnings report, the company said China presents "significant challenges."

So what does that exactly mean, what impact is China having on Qualcomm's bottom line and how should investors interpret the headwinds the company admits it's facing in China?

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For one, Chinese domestic handset makers that rely on Qualcomm's technology have signed license agreements and are on the hook for extensive royalty payments.

And that's revenue Qualcomm is counting on.

FBR's Chris Rolland estimates if a Chinese company sells a $200 smartphone using Qualcomm technology, then that firm is on the hook to pay Qualcomm at least $8 per phone.

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But Qualcomm said on its last earnings call that these domestic Chinese smartphone manufacturers are either not paying the royalties, or underreporting the number of phones they're selling.

Mobile world immersion
Mobile world immersion

And that's where the problem lies for Qualcomm, because its licensing business represents about 30 percent of the company's total revenue.

Analysts say the uncertainty about what's going on in China is having an impact on Qualcomm's stock price. Qualcomm shares have gained less than 4 percent in 2014, and have lost more than 2 percent in the past six months. But not all analysts are worried about Qualcomm's woes in China.

CLSA's Srini Pajjuri has an outperform rating on Qualcomm shares and a $90 price target. In a recent note, Pajjuri wrote "even if we assume that China royalty revenue goes to zero, the stock is trading at 17x, suggesting that a near worst case scenario is priced in." He adds that top tier Chinese phone manufacturers like Huawei, Lenovo, Xiaomi, Coolpad and ZTE are "complying."

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However, Qualcomm's problems in China don't stop with its licensing and royalty woes. Qualcomm recently also disclosed that the Chinese government is investigating the company under the country's anti-monopoly law. RBC's Mark Sue says it could be another 12 months before there is clarity on that investigation and ongoing dispute.

The bottom line for Qualcomm investors: China represents close to 20 percent of Qualcomm's revenue and the company for years has counted on China for future growth.