OT Here's the PaineWebber report on QCOM. i own both EMC AND QCOM. good reading!!>
TELECOM EQUIPMENT
Walter Piecyk
212-713-4075/piecykw@painewebber.com RESEARCH NOTE
Joseph Galone, Associate Analyst (212-713-2860) December 29, 1999
Qualcomm Inc. Rating: Buy
(QCOM-$503.00)[2]
QCOM: INITIATE COVERAGE WITH BUY RATING & $1000 TARGET
KEY POINTS
ú We are initiating coverage of Qualcomm with a Buy rating because we believe it represents an appropriate way to
invest in the long-term growth trends of wireless and data.
ú Qualcomm, the developer of Code Division Multiple Access (CDMA) wireless technology, sells over 90% of the
Application Specific Integrated Chips (ASIC?s) used in CDMA phones and collects royalties for all CDMA phones.
ú We believe by the end of the next decade 85% of phones sold will use CDMA technology (up from 18% today)
resulting in over 45% CAGR for CDMA and up to a $20 billion royalty stream for Qualcomm.
ú Qualcomm's ASIC business could get stronger as China and Brazil begin to ramp up growth and Nokia, Motorola and
Ericsson consider using Qualcomm?s new 2.5G enabled chips.
ú We estimate that Qualcomm?s recently announced sale of its money-losing phone business will enable it to expand
pre-tax margins to over 40% in 2000 and over 50% in 2001 from less than 20% in 1999.
ú Our 12-month price target of $1,000 implies 175x and 55x our 2001 profit and revenue estimates but is based on $800
for the present value of its royalty stream, $170 for 60x its ASIC profits and $30 for other assets.
Key Data Quarterly Earnings Per Share (fiscal year ends September)
52-Wk Range $522-25 1999A 2000E Prev 2001E Prev
Eq.Mkt.Cap.(MM) $100,600 1Q $0.33 $0.97 $1.15
Sh.Out.(MM) 200.0 2Q 0.41 0.98 1.24
Float NA 3Q 0.75 1.06 1.37
Inst.Hldgs. 51.1% 4Q 0.91 1.17 1.56
Av.Dly.Vol.(K) 4,878 Year $2.38 $4.18 $5.32
Curr. Div./Yield None/NA FC Cons.: $2.38 $4.06 $5.24
Sec.Grwth.Rate NA Revs.(MM): $4,200 $3,500 $3,500
12-mo. Tgt Price $1,000.00 P/E: 211.3x 120.3x 94.5x
12-mo. Ret. Pot?l 98.8%
Convertible? No
PE/Growth 1.6x
Risks: Qualcomm competes in a highly competitive market with currency, political and financing risk. A significant % of its profits are generated by
royalties on a technology and are subject to challenge and development of new competitive technologies.
WIRELESS AND DATA GROWTH
We expect Qualcomm to be a primary beneficiary of the
convergence of wireless and data. Qualcomm?s key
patents entitle it to royalty payments for CDMA; a digital
wireless technology that we believe will be predominantly
selected over the next decade to enable high-speed data
connections on wireless networks. Its early lead in
supplying key CDMA components provides another
opportunity to leverage the growth in this technology. We
initiated coverage with a Buy rating and a $1000 price
target. The stock is expected to split 4:1 tomorrow.
3G IS CDMA
The convergence of wireless and data over the next
decade will lead to a demand for higher connection speeds
between the terminal (now a cell phone) and the cell sight.
Third Generation wireless technologies promise to
accelerate wireless data transfer rates to cable modem and
DSL speeds of 2 MBPS from the less than 56 KBPS being
offered today. Our discussion with operators, equipment
suppliers and technology consultants lead us to believe
that CDMA is the most efficient technology for increasing
data transfer speeds. International organizations also
appear to be settling on CDMA as the standard.
QUALCOMM Inc. designs, develops, makes, sells, licenses and operates advanced communications
systems and products based on proprietary digital wireless technology.
Page 2 of 3 asd
CDMA IS QUALCOMM
Qualcomm holds key patents for the CDMA digital wireless
technology, which it then licenses to telecom suppliers of
phones and infrastructure. We estimate that each CDMA
phone sold generates a 4.5% royalty payment to
Qualcomm. While this royalty stream represents 20% of
top line growth in 2000 we estimate it represents 50% of
Qualcomm?s 2000 profit and is the key driver of growth.
85% OF PHONES CDMA BY 2010
We believe that by the end of the next decade 85% of
phones sold will use CDMA technology, up from 18% of
phones sold in 1999. Many of the phones are likely to be
dual-mode, incorporating other technologies. While we
expect the total handset market to offer a 30%
compounded annual growth rate (CAGR) over the next 10
years, this gain in the share of the total handset market is
likely to lead to 45% CAGR for CDMA over the same
period.
$20 BILLION ROYALTY STREAM = $800 PER SHARE
The 45% CAGR of CDMA phones sold could result in a
$20 billion royalty stream for Qualcomm by the end of the
decade. This estimate is highly sensitive to assumptions,
as is any long-term projection. Our estimate assumes that
3 billion phones are sold in 2010 with an average sale price
(ASP) of $180 and a royalty rate of 4.5%. If we apply a
97% operating margin and 35% tax rate we are left with
$13 billion of free cash. Using a terminal multiple of 60x
and a discount rate of 20% yields a present value of $800
per share of Qualcomm?s stock. In a second note we
examined sensitivities to these assumptions.
ASICS: THE HEART OF CDMA
Qualcomm commands over 90% market share in the sale
of ASICS used in CDMA phones, despite little or no sales
to Nokia, Motorola and Ericsson, which represent 60% of
the total handset market. Nokia and Motorola decided to
design their own chips and as a result were substantially
late to market. Ericsson is not yet in the CDMA market.
We believe that over the next five years each of these
suppliers could buy a substantial portion of their CDMA
ASIC?s from Qualcomm. In fact the integration of multiple
technologies on one chip could result in Qualcomm being
the largest supplier of ASIC?s for the entire industry.
NOKIA, MOT AND ERICSSON TO BUY QCOM ASIC?S
We believe the catalyst to incite Nokia and Motorola to use
Qualcomm chips will be the rollout of 2.5G (1XRTT)
wireless data services over the next year. Sprint PCS
(PCS-$104.38), a stock we cover, has told us they want all
new phones sold to have the latest wireless data
technology, even if that customer does not activate those
services when buying the phone. Sprint PCS, practicing
what they preach, recently lowered its order of Nokia
phones because of Nokia?s inability to deliver a working
web-browser. Rather than develop their own 2.5G capable
chips and risk being late to market again, we believe
Motorola, Nokia and Ericsson will buy Qualcomm chips.
EXPECT 100 MILLION CHIPS TO BE SOLD IN 2001
We expect Qualcomm to double the number of ASICs sold
to 100 million in 2001 from 50 million in 1999. We expect it
to make 73 million ASIC?s next year. The higher integration
of software and functionality into the chip including data
speeds, voice recognition, location, etc., are likely to
moderate ASP declines and strengthen margins.
Qualcomm would however provide some concessions to
attract large buyers like Nokia and Motorola.
$170 FOR THE ASIC BUSINESS
We estimate over $2 billion in ASIC revenue and over $860
million in pre-tax profit in 2001. Similar companies with
lower growth rates command 40-50x taxed profit multiples.
We believe Qualcomm?s dominant market share, high
growth industry and ability to initiate new relationships with
each of the three largest buyers of components over the
next six months justify a 60x multiple of taxed 2001 profit of
$560 million. This results in a $170 price target for
Qualcomm?s ASIC business alone.
$30 FOR OTHER BUSINESS
Qualcomm operates a wireless network with over $300
million in revenue worth $25 per share based on 40x its
profit. Its equity holdings, contract services and mobile
phone sales to GlobalStar (a business model that we do
not believe works) as well as a wireless data joint venture
with Microsoft account for the balance.
THE FUTURE
The future of wireless is not checking sports scores on a
cell phone. The use of bluetooth technology and voice
recognition will remove the need for a screen, keypad,
microphone and speaker. The key components that remain
are the technology, chips and power supply. Higher data
speeds are likely to enable the same applications enjoyed
on the desktop today. That business model would likely
include the imbedding of wireless components into most
consumer electronic products. Qualcomm licenses the
technology and sells the component required to make that
future a reality. Any news or perception impacting our
underlying assumption of strong wireless growth or CDMA
as the best technology for the convergence of wireless and
data would have a dramatic impact on our, and the
market?s, view of the valuation of Qualcomm, even if that
news was incorrect. In short this is a volatile stock.
Additional information available upon request.
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