According to a recent report from news agency Reuters, Apple Inc. (AAPL) rejected an offer from Samsung Electronics Co that would have helped the U.S. company secure a quick court ruling over the patent infringement case it currently fights with the Korean company in Australia.
Of course, the offer came with a rider. In return for its help in expediting the legal process, Apple was asked to immediately allow Samsung to launch its new Galaxy tab in Australia. Samsung had hoped to launch the new Galaxy tablet in Australia in late August or early September but this has been repeatedly delayed as it awaits the Australian court’s ruling.
Samsung has also agreed to withdraw two features from the Galaxy 10.1, leaving just one disputed Apple patent over touch-screen display technology. However, we believe the offer was ridiculous as the main motive behind Apple’s patent infringement cases against Samsung was to stop the launch of the Galaxy tablet which has been touted as the strongest competitor to iPad.
We also believe that Apple’s rejection reflects its strong conviction of receiving a favourable judgement. Apple has already secured a block on the latest Galaxy tablets in Germany and some Samsung smartphone models in the Netherlands.
We believe a block in Australia will not only do severe damage to Samsung’s bid to close the gap with Apple in the global tablet market, but will also hurt its top-line growth going forward. Moreover, rising pressure on Samsung may force the Korean company to pay a hefty licensing fee, which will drive Apple’s top-line growth going forward.
Apple and Samsung: An Overview
Apple and Samsung were long term allies. Samsung manufactured the A4 processor used in the original iPad, along with the processor used in the iPhone 3GS. In February 2011, Apple signed a $7.0 billion deal with Samsung to buy flash memory in bulk for its iPhone and iPad product lines.
However, their relationship soured due to Samsung’s aggressive push into the smartphone and tablet market. In the second quarter of 2011, Samsung’s smartphone sales soared more than 500%, much faster than Apple’s 142% growth, though Apple sold 1 million more units. Apple is determined to protect its dominant position in the smartphone and tablet market (iPhone and iPad comprises 65.0% of total revenues), which has resulted in a number of lawsuits.
Apple has accused Samsung of not only copying its technology but also user interface and product design. Apple’s original suit (April 2011) accuses Samsung of infringing on seven technical patents related to user interaction, specifically pinching, zooming, scrolling, and selecting. Apple also says Samsung violates three design patents, including one covering the flat black face of the iPhone and iPad. The suit was targeted at the Samsung Nexus S, Epic 4G, Galaxy S 4G, and Galaxy Tab.
Samsung counter attacked by filing a number of suits in different countries. Samsung’s counter-suits allege that Apple’s iPhone and iPad infringe on selected Samsung wireless communication patents covering methods of handling phone calls and data simultaneously, reducing interference between devices, processing text messages and attachments, and improving network efficiency.
In South Korea, Samsung accused Apple of violating five patents; in Germany, the allegation was for three patents, whereas in Japan two patents are involved in the dispute. In the United States, Samsung is basing its counterclaims against Apple on 10 alleged patent infringements. These are the same technology patents Samsung is expected to use as the basis of a new lawsuit against the iPhone 5, when it debuts (expected October 2011).
Currently, Samsung and Apple are suing each other in nine countries over 20 cases. Both the companies are keeping their fingers crossed as they expect a crucial California court ruling next week.
Apple is reportedly looking to diversify its supplier base due to the sour relationship with Samsung and has approached Taiwan Semiconductor Manufacturing Co. to make the latest A6 processor chips.
Apple’s Primary Target: Google
We believe Apple is fighting a proxy war against Google Inc.’s (GOOG) Android operating system by firing lawsuits against handset makers Samsung and HTC. Apple’s iOS operating system is facing significant competition from Android in both the smartphone and tablet market.
Android being open source has helped Apple’s competitors to create differentiated devices based on the free source code. We think this feature has helped iPhone competitors pick up significant market share. In the second quarter of 2011, android accounted for 43.4% of all smartphone sales, up from 17.2% from the year-ago quarter, while Apple reached 18.2%, up from 14.1% at the same time.
According to research firm Gartner, by 2014, open-source platforms will continue to dominate, accounting for more than 60% of the market for smartphones. Single-source platforms, such as Apple’s iOS and Research In Motion’s (RIMM) OS, will increase in unit terms, but their growth rate will be below market average and not enough to sustain share increase.
We also believe that the favorable decisions against Samsung will encourage Apple to fire lawsuits against other handset and tablet manufacturers using android particularly in the emerging markets of the Asia-Pacific where they are immensely popular due to the low price of their devices. According to market research firm Canalys, Android holds 48.0% of the smartphone market share in the Asia Pacific region with 35 of the 56 countries using it as the #1 platform.
Apple is also using its huge balance sheet to pile up patents, which will increase its competitive edge against the Android onslaught. Recently, Apple, Microsoft Corp. (MSFT) and RIM teamed up with three other companies to outbid Google at an auction for Nortel’s wireless patents. Android uses some of the intellectual properties which are not created by Google itself but have certain features similar to the Nortel patents. We believe the loss of Nortel assets to rivals such as Apple and Microsoft could push Google to pay big licensing fees.
Apple also acquired approximately 40 patents in China which bodes well for Apple going forward. We are appreciative of Apple’s approach of acquiring patents, which will lead to incremental growth in China, as well as in other emerging economies in the Asia-Pacific over the long term. Apple’s ability to spur the popularity of its products in developing nations, where pricing is often an important consideration, will go a long way toward deciding the company’s future growth.
Apple’s new iPhone 4S is expected boost its market share going forward in our view. However, increasing competition and various lawsuits keeps us cautious. We maintain a Neutral rating on a long term basis (6-12 months). Currently, Apple has a Zacks #2 Rank, which implies a Buy rating in the short term.