Qualcomm hurdles the Great Wall
By R. Scott Raynovich
Redherring.com, February 02, 2000
SAN FRANCISCO -- Qualcomm (Nasdaq: QCOM) scored a strategic victory Tuesday
when it landed a deal with major Chinese wireless provider China United
Telecommunications (China Unicom), but the deal's impact on Qualcomm's earnings
and top-line growth is not likely to be figured out for years to come.
Under the agreement, Qualcomm will license its Code Division Multiple Access (CDMA)
digital wireless technology to China Unicom in exchange for royalty payments and
potential future chipset sales. Analysts and observers say the deal will expand the
footprint of Qualcomm's CDMA products, but they note that the lack of details about
royalty payments and potential chip sales -- as well as uncertainties in the Chinese
market -- prevent anybody from calculating the exact earnings potential.
"The revenues will be substantial, but it's hard to say exactly how big they will be, and
we haven't crunched the numbers yet," said Erik Weir, president of Weir Capital, who
was on hand for Qualcomm's presentation at the Bank of America Technology Week
conference being held here this week. "I believe they are establishing the de facto
standard, and we're very excited about what's going on in China," says Mr. Weir, who
says his fund has held a significant position in Qualcomm stock and "added to it
recently."
Qualcomm shares, which had declined significantly in the past few weeks after an
eye-popping run-up of more than 2,000 percent in 1999, closed up $9.06 (7.14
percent) to $136.06 on the news.
MURKY DETAILS
Qualcomm officials declined to publicly discuss the specific royalty relationship or give
revenue estimates for the partnership, but several sources who met with the
company at the conference said the royalty payments being discussed were in the
"single digits" per wireless telephone handset. Estimates for the number of handsets
expected to be deployed in the next couple of years range up to 10 million, according
to fund managers and analysts following the company.
The deal is strategically important to Qualcomm, which is aggressively expanding the
global reach of its CDMA technology. In the conference presentation, company
officials said they hope that CDMA will eventually surpass the Global System for Mobile
communications (GSM) wireless standard, which is used widely around the world,
though not much in the United States.
"CDMA will be the leading wireless system; it's just emerging even though we've been
playing with it for 10 years," said Qualcomm President and Chief Operating Officer
Richard Sulpizio in a conference presentation. Mr. Sulpizio said that Qualcomm's
strong intellectual property position with CDMA -- the company holds 266 patents
related to the technology -- will ensure that it benefits from its widespread adoption.
Mr. Sulpizio said the company's focus is on the expansion of the wireless chipset
business. It plans to develop new lines of chips based on the CDMA and GSM
standards, as well as develop chips for forthcoming broadband wireless technologies
such as its High Data Rate (HDR) technology, which company officials say will transmit
wireless data at rates of up to 2Mbps (megabits per second).
CHIPS FOR CHINA
China Unicom will use CDMA to compete with China Mobile, the former state carrier of
China. While both companies are owned by the Chinese government, they are
encouraged to compete with one another. China's wireless infrastructure, dominated
by China Mobile, is predominately GSM.
"I would look at China Unicom as Sprint (NYSE: FON), or the newcomer," says Mark
McKechnie, a research analyst at Banc of America Securities. "The idea is to grow the
CDMA footprint. China is a huge country, so it will take a while."
Mr. McKechnie estimates that the partnership between Qualcomm and China Unicom
would result in three to five million new CDMA wireless subscribers being added in
China in 2001, with Qualcomm seeing royalties of about $8 per handset. But Mr.
McKechnie notes that Qualcomm will also profit from the CDMA chipsets it sells to
power those phones. The CDMA chips sell for about $25 each, on which Qualcomm
could earn a profit of about $8 per chip, he says.
Even those kinds of numbers might not bump Qualcomm's highly valued stock.
Qualcomm trades at a price-to-earnings ratio of about 126, and with a market
capitalization of $83 billion, it may mean that expectations of aggressive global
growth are already built into the stock.
"It was a major victory in the CDMA food chain, but the stock's going to go all over
the place," says Mr. McKechnie, who maintains a Buy rating and a $165 price target
on the stock. That target is based on McKechnie's estimates of applying a valuation of
120 times estimated earnings of $1.38 per share in 2001.
One fund manager who met with Qualcomm officials at a breakout session that was
closed to press said that company officials were talking about 10 million new phones,
with royalty payments of $5 each. "Those numbers are so aggressive," said the fund
manager, who asked to remain unnamed. "My personal feeling is that its [share price
is] high, and I was recently a seller of Qualcomm."
Stocks that trade at such high multiples are subject to sell-offs when a company
"hiccups," or disappoints investors, as Qualcomm did in its January 25 conference call
for the fiscal first quarter of 2000. In that call, company officials said that the growth
of chipset sales may slow in the early part of this year because of inventory
difficulties. That announcement resulted in a sell-off in Qualcomm shares. For the
period ending December 26, the company reported $1.1 billion in sales and a quarterly
profit of .23 cents per share.
Mr. McKechnie noted that he was excited about other areas of Qualcomm's business,
such as the development of future broadband versions of CDMA and dual-mode
chipsets that could power phones that run on both the CDMA and GSM standard.
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