Qualcomm: Down But Not Out -- The company's share price has fallen 65% from its peak in January, but it's still a good way to invest in the growing wireless market
CMP Media Inc. - June 03, 2000 00:34
Jun. 02, 2000 (InformationWeek - CMP via COMTEX) -- You're probably relieved to find me talking about companies again after two weeks of the "modern portfolio." Now that the market correction has hit most of technologyland, let's look at one of the downtrodden names.
A company that has popped up on my radar screen is Qualcomm Inc. (QCOM-Nasdaq), one of the leaders in Code Division Multiple Access (CDMA) wireless technologies. Qualcomm last year and early this year was a favorite of almost every momentum trader and technology investor; the company's share price hit $200 on Jan. 3. The price, however, has since plummeted to around $70.
There's a lot to like about Qualcomm, particularly given the boom in the wireless market. Domestic wireless subscriber rates continue to grow in excess of 40% per annum, and CDMA handset sales are growing more than 70% yearly. There's also the explosion of wireless telephony, with much of the world moving toward adoption of CDMA technologies. Another positive factor is the migration of the Web to wireless applications. According to Salomon Smith Barney, the mobile data market will mushroom from $8 billion this year to more than $25 billion by 2005. It's small wonder that investors have jumped whenever someone mentioned the initials QCOM.
Unfortunately, investors forgot about Qualcomm's risks. Major handset competitors such as Nokia Corp. (NOK-NYSE) and Motorola Inc. (MOT-NYSE) have been dominating market share, and they manufacture most of their own chipsets. They also have a major impact on handset prices, which directly impact Qualcomm's royalty streams. Another drawback for Qualcomm is that Korea, one of its biggest markets, has a penetration rate exceeding 50%, which almost guarantees a sales slowdown (combined with the Korean government's decision to end subsidies of handset prices).
I also wouldn't be surprised if the rollout of third-generation wireless technologies was slower than expected. There is concern about the differences in licensing and royalty payments, as well as competitive implementations, for third-generation wireless platforms.
In Qualcomm's fiscal second quarter, which ended March 31, the company reported pro forma revenue of $649 million, up 16% from $558 million in the same quarter last year. Earnings per share were 26 cents vs. 18 cents in the year-ago quarter, up 44%. Chipset sales grew 5% year over year to $279 million from $265 million but were down 20% from last quarter. Chipset sales should rise from 11.2 million units in the second quarter to around 15 million units in the third fiscal quarter, ending June 30. The unit's operating margin was 32%.
Qualcomm's wireless systems division grew 5% year over year to $188 million with operating margins at a robust 44%; this figure is likely to dip to the mid-30s. Revenue from the technology licensing group was up 57% year over year to $149 million.
The company's financial structure changed dramatically last year when it sold the low-margin consumer-products division (including handsets) to Kyocera Corp. and its infrastructure business to LM Ericsson. This was reflected in an increase in gross margin in the latest quarter to 51.5% from the previous quarter's 35.6%. Operating margin increased to 21.2% from 16.4%.
I'm not a big fan of Qualcomm's spending $144 million for a 9.9% stake in NetZero Inc. (NZRO-Nasdaq), a free consumer-oriented Internet service provider. In return for this investment, NetZero will make Qualcomm's Eudora product the preferred E-mail client for NetZero subscribers and will share ad revenue with Qualcomm. Unfortunately, like many of these speculative deals, the fair market value has been cut by almost 40% since the purchase announcement in April. Consensus earnings per share estimate for Qualcomm in fiscal 2001, ending Sept. 30, is $1.42; I expect an upside to this number in 2001. This implies a forward price/earnings multiple of around 50 times at the current share price of $70.
Though Qualcomm is likely to grow at 35% to 40% per year for the near future, the decline of 65% from its peak share price is not a sound rationale for investment; it should never have gotten to $200. At $70, the stock is a better buy but still not cheap. It was selling at $24 a year ago and the price is only back to where it was in November. You are still paying up for this company, though it remains a good way to invest in the growth of wireless and CDMA.
William Schaff is chief investment officer at Bay Isle Financial Corp., which manages the InformationWeek 100 Stock Index. Reach him at bschaff@bayisle.com.
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