Bloomberg News

HTC Loss to Apple on Patents Casts Doubt on S3 Graphics Buy

November 30, 2011

(Updates HTC share price in fifth paragraph.)

Nov. 22 (Bloomberg) -- HTC Corp.’s loss in a patent infringement case against Apple Inc. casts doubt on its decision to spend $300 million buying S3 Graphics Co. to boost the chances of a licensing deal to end the dispute.

The U.S. International Trade Commission said yesterday that S3 Graphics’s patent rights weren’t violated by Apple, rejecting a request for an order that could have limited imports of some Mac computers, the iPhone and iPad. The commission gave no reason for its decision. HTC said it may challenge the ruling in a U.S. appeals court that specializes in patent law.

HTC, which sold the most smartphones in the U.S. in the third quarter, said it would buy Fremont, California-based S3 Graphics less than a week after a trade agency’s judge issued his findings in the case in July. S3 Graphics was part-owned by HTC Chairwoman Cher Wang, and Citigroup Inc. analyst Kevin Chang said at the time HTC could have just licensed the patents.

A decision against HTC “calls into question the rationale of the S3 acquisition,” said Chen Fu-li, an analyst at E Sun Securities Co. in Taipei who has a “buy” rating on HTC shares. “It’s the final decision so it’s quite important. A negative decision could put pressure on HTC’s shares.”

S3 Graphics Purchase

HTC slid as much as 6.1 percent, the biggest intraday decline in almost two months, to NT$598 before trading at NT$613 as of 10:45 a.m. in Taipei trading today. The stock has tumbled 50 percent since a record high of NT$1,238 on April 28.

HTC Chief Executive Peter Chou has built the former contract manufacturer into a global brand by customizing its phones for carriers including Verizon Wireless and Sprint Nextel Corp. The company almost doubled its revenue last year and has posted six consecutive quarters of record profit.

S3 Graphics makes image-compression technology, and its Texture Compression feature is used in Nintendo Co.’s Wii and Sony Corp.’s PlayStation portable gaming systems. The purchase by HTC included about 235 patents, mostly related to graphics technology.

“S3 can be innovative and they came up with some nice products, but whether they are relevant to Apple is debatable,” Shaw Wu, an analyst at Sterne Agee & Leach Inc. in San Francisco, said in an interview. “Apple has a lot of patents, so it’s going to be tough to beat Apple.”

Graphics Patents

The decision marks the first time the six-member commission has ruled on one of the dozen cases at the agency stemming from the battle for the smartphone market. S3 Graphics has another trade case pending against Apple over four other patents, and HTC has two of its own cases, including one in which it asserts patents obtained from Google Inc., the developer of the Android operating system.

“We are disappointed, but respect the ITC’s decision,” HTC General Counsel Grace Lei said in an e-mailed statement yesterday. “While the outcome is not what we hoped for, we will review the ruling once the commission provides it and will then consider all options, including appeal.”

U.S. trade Judge James Gildea on July 1 found that some Apple Macs infringed two S3 Graphics patents related to graphics chips, while the mobile platform for the iPhone didn’t infringe. The six-member commission reviewed the entire decision, including the effects of Apple’s agreements with Intel Corp. and Nvidia Corp. for graphics chips.

Patent Fights

HTC was counting on a victory to bolster its patent battles with Apple. The commission is also reviewing an agency judge’s determination that HTC infringed two Apple patents, with a decision expected Dec. 6, and may take a look at a judge’s findings that cleared Apple of infringing HTC patents.

“Apple’s win strikes the first blow in its wide-ranging patent fight with HTC,” Mike Abramsky, an analyst at RBC Capital Markets in Toronto, said in a note to clients.

Kristin Huguet, a spokeswoman for Apple, said the Cupertino, California-based company had no comment.

HTC and Apple are among smartphone makers, including Samsung Electronics Co. and Motorola Mobility Holdings Inc., using patents to challenge competition in a market projected by researcher IHS Inc. to reach $206.6 billion this year.

Apple is targeting phones and tablet computers that run on Google’s Android operating system. Apple, which has two cases at the trade commission against HTC, is seeking to block imports of HTC phones that run on Android.

Top Seller

Smartphone sales by volume increased 42 percent in the third quarter, according to research firm Gartner Inc. HTC became the top seller of smartphones in the U.S. in the third quarter, with 24 percent of the market, above Samsung Electronics’s 21 percent and Apple’s 20 percent, according to Palo Alto, California-based researcher Canalys.

Gildea’s initial ruling didn’t apply to Apple mobile devices or Mac computers with Nvidia graphics processing units that have an implied license to the patents, the judge determined. The judge also found that two other S3 patents were invalid, as were aspects of the two patents found to be infringed.

The decision was limited to a “small software module in Mac OS,” Apple said in a Sept. 23 filing with the agency.

Apple argued that the patents were invalid and not infringed. It also contended that Advanced Micro Devices Inc., not S3 Graphics, is the proper owner of the patents. AMD has filed a suit in federal court seeking an ownership ruling. The commission denied AMD’s request to intervene in trade case.

Apple Sales

Even if a violation is found, Apple argued in the filing, the commission shouldn’t ban any imports until a further hearing on AMD’s claims and on the effect on the public interest of halting any products.

S3 Graphics responded in its own filings with the agency that AMD didn’t own the patents, and other electronics compete with Apple’s products, so there’s no harm to consumers or the overall market demand for smartphones by blocking the Apple products from the U.S.

The iPhone brought in $47 billion in sales last fiscal year, or 43 percent of Apple’s revenue, while Macs generated $21.8 billion in sales, 20 percent of Apple’s revenue. HTC said in its August trade complaint that it had about $5 billion in U.S. sales last year.

The case is In the Matter of Certain Electronic Devices with Image Processing Systems, 337-724, U.S. International Trade Commission (Washington).

--With assistance from Mark Lee in Hong Kong, Tim Culpan in Taipei, Adam Satariano in San Francisco and Sarah Frier in New York. Editors: Steve Walsh, Frank Longid

To contact the reporter on this story: Susan Decker in Washington at sdecker1@bloomberg.net

To contact the editors responsible for this story: Michael Shepard at mshepard7@bloomberg.net; Michael Tighe at mtighe4@bloomberg.net


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