I did a bit of surfing; this reprint on Fool from Briefing.com should clear things up:
IDC: You're No Baby QCOM
Daily Stock Brief by Briefing.com
Updated: 13-Jan-00
InterDigital Communications
[BRIEFING.COM - Robert V. Green] Whenever we kick the tires on a
concept investment, we get a flood of emails from true believers who don't
like it. This happened recently with InterDigital Communications (IDC), a
stock which rose from $5 to $80 on the concept that it is a "baby
Qualcomm." Since everyone and their grandmother wishes they had bought
Qualcomm a year ago, the very phrase is enough to get some investors to
take action. But IDC isn't a baby Qualcomm.
The Baby Qualcomm Concept
Qualcomm (QCOM) firmly established their CDMA format, as a royalty
bearing vehicle, before selling off their infrastructure business and, now,
their handset business.
When people say that IDC is a "baby Qualcomm" they primarily mean that
IDC will also be a royalty model, with revenues on the scale of Qualcomm
($4 billion). The royalty model is valuable because it is leveraged. Operating
margin increases as revenues increase.
These are the key reasons Qualcomm rose from $25 to $600 in one year:
CDMA made giant steps against the dominance of GSM phones (the
acceptance by China of CDMA helped this a lot. Previously China
was an all GSM wireless infrastructure, and there was essentially no
CDMA infrastructure at all. )
Qualcomm settled patent suits with Ericsson. (The acceptance by
China Unicom of CDMA, and their announcement of plans to build a
CDMA infrastructure with 40 million user capacity, came one day
after the settlement with Ericsson was announced. We don't think the
settlement was a coincidence. Ericsson was/is the dominant vendor in
China, but any move to CDMA would hurt them. )
Qualcomm moved much closer to a leveraged business model. The
market values this leverage much more highly than manufacturing
models.
Qualcomm began investing in the next generation of wireless
broadband (HDR).
Momentum players poured into the stock.
Qualcomm established a proven royalty stream based on CDMA before
moving to the more leveraged business model they have now embraced.
The moniker "baby Qualcomm" began being applied to IDC because IDC
is essentially an intellectual property engineering firm. In the same way that
Aware (AWRE) and fabless semiconductor companies develop
technology, then license the manufacturing to others, IDC's business model
involves development and licensing of new technology. They do not
manufacture or distribute physical product on their own.
The problem with IDC, which is where our "tire-kicking" comes in, is that
the expected royalty stream coming to IDC is unproven. The current royalty
stream is based on existing TDMA and CDMA license agreements, but a
quick glance at IDC's quarterly revenue stream shows that that stream is
dying, not growing.
Five Wrong Premises Behind the "Baby Qualcomm" Idea
Here are some of the premises that were emailed to us, in argument that
IDC truly was deserving of the title "baby Qualcomm." Briefing.com called
both IDC and Qualcomm to test these premises. Here is what we found.
Premise 1: Qualcomm pays IDC royalties because IDC owns CDMA
patents. IDC does own CDMA patents. But Qualcomm and IDC settled
any ownership dispute over these patents in 1994 with a single one-time
payment to IDC from Qualcomm and a perpetual license agreement.
IDC receives no current royalties from Qualcomm on an ongoing basis.
Numerous emailers to us claimed that they do. Where this idea comes from,
we have no idea. Even a brief look at IDC's revenue stream should
convince anyone that they aren't participating in the boom that Qualcomm
enjoyed. Nevertheless, we asked both companies and both IDC and
Qualcomm verified that no current royalty relationship exists between the
two companies.
Premise 2: Qualcomm will pay IDC royalties in the future for 3G
CDMA phones, because the 1994 lawsuit does not cover technology
needed for 3G phones.
IDC does own patents on B-CDMA technology, which is not covered by
the 1994 settlement.
But this is irrelevant to Qualcomm's future. Qualcomm stated unequivocally
to Briefing.com that they "don't see any need for Qualcomm to use any
existing IDC patents in the future" and that they "do not expect to pay IDC
royalties" going forward. It can't be any clearer.
Premise 3: Everyone building a 3G phone will pay IDC a royalty in
the future. This premise is based on the idea that IDC owns essential
patents for the 3G standard.
IDC is developing technology for the 3G standard, but so are many others.
IDC has not identified to ITU any specific patents that would require
royalty payments, to anyone, not just Qualcomm. (Source: Both IDC and
Qualcomm.). Such an assertion would be standard procedure for any
vendor submitting technology to an international standards board. Any
presumption that IDC will own royalty-bearing intellectual property for 3G
technology that is sanctioned by ITU is currently just a presumption.
Premise 4: Every current GSM and TDMA phone vendor owes IDC
money for past infringement and it amounts to billions. This idea falls
into the "maybe" category. It stems from the idea that the current
Ericsson/IDC cross lawsuits are going to result in a judgement for IDC, and
that back royalties will be awarded. The idea is exciting because of the vast
amount of phones sold which are claimed under the lawsuit.
But prejudging the outcome of any lawsuit, with your investment dollars, is a
very risky proposition. Furthermore, the trial schedule is not expected to
conclude, according to IDC, until the end of 2000 or early 2001. The April
date that numerous emailers pointed to is only a hearing, with a single judge,
and will not result in final disposition of the case. An investment on this
premise requires at least a year's time frame.
Furthermore, even if IDC wins, there is no assurance that the royalty
payments would amount to "billions." But even a judgement in the hundreds
of millions wouldn't justify the current market cap of IDC, in our view, if it
were a one-time payment.
Many people emailed us saying that a judgement for IDC was a given, since
the Patent Office recently reaffirmed existing IDC patents. But a
reaffirmation by the Patent Office is a nonevent, in patent litigation.
When patents are overturned, it happens in court, not by the Patent Office.
A reaffirmation is obviously a positive sign, but it does not mean that the
IDC patents cannot be declared invalid.
Premise 5: IDC is currently receiving royalty payments from Nokia,
and will in the future. Numerous people stated that Nokia is already
paying IDC in the neighborhood of $40 million in royalty payments for IDC
intellectual property, and therefore IDC will receive something for every 3G
Nokia phone going forward.
Nokia has contracted with IDC for technology development that might be
part of Nokia's 3G technology. The bulk of the Nokia payments so far
represent development costs, although the payments also include a
prepayment of licensing rights to a limited extent. This was verified by
Briefing.com directly with IDC, although IDC would not comment on any
possible royalty relationship into the future, or the terms, if any, of future
royalty payments Nokia might make.
While it is obviously positive that Nokia has employed IDC, investors
should realize that Nokia has its own development group working on the
same essential technology that IDC is working on. IDC acknowledged that
the work being done for Nokia was not Nokia's sole 3G technology effort.
(We were unable to confirm with Nokia.)
Possibilities For IDC
While we think the "baby Qualcomm" concept is an erroneous way to look
at IDC, it doesn't mean that IDC isn't a possible speculative play.
Here are three real possibilities to justify an investment in IDC, but
everyone of them currently has no proven revenue stream.
Chip sales: IDC is currently working with Texas Instruments to
develop B-CDMA chips. IDC is also looking for additional
relationships with semiconductor manufacturer to build IDC designed
chips. This "fabless" semiconductor relationship is an established
model in the semiconductor industry. But it requires demand for IDC
designs. Unfortunately, there is not, to date, an established stream of
revenue from sale of these chips upon which to formulate an estimate
of market demand.
Nokia relationship: The Nokia relationship has possibilities. But since
a future royalty stream can't be confirmed, even directly from IDC, it
is hard to quantify what this means. But IDC will own the intellectual
rights to any technology they develop for Nokia, meaning they can
license whatever they develop to anyone else. That is a good position
to be in, but it doesn't mean that anyone wants, yet, what IDC owns.
The Ericsson suit: It is always possible that IDC will receive a large
settlement for past patent infringement. But without knowing what
IDC would do with the money, it is a lottery ticket with an unknown
payoff. All it really means is IDC would have no capital problems.
But that doesn't guarantee future earnings.
Actually, for us at Briefing.com, all of these would be interesting
propositions, at the right price. Unfortunately, IDC is way beyond that price
(IDC closed yesterday at $30 1/8.)
We aren't alone in being uncomfortable about an inability to quantify IDC's
future business plans. The sole analyst covering IDC, Ram Kasargod, of
Morgan Keegan, dropped coverage on 1/11/00 because no details of
possible revenue streams were available, upon which to base a valuation.
Final Analysis
None of this discussion means that IDC will fail, or that IDC stock will
drop, or rise.
But we believe that any investment needs to be analyzed on a risk/reward
basis. With IDC, it is rather easy to calculate the risks, but nearly
impossible to calculate the rewards. Qualcomm, on the other hand, is not a
speculative investment in any way, although you might argue about the
valuation.
Nevertheless, speculation is appropriate for some investors, as long as you
recognize what it is. Somehow, we have a feeling that most who bought on
the "baby Qualcomm" concept never really understood IDC.
Comments can be emailed to the author, Robert V. Green, at
rvgreen@briefing.com. |
