I know I'm responding to a post of yours of last Thursday. However, I thought that the board might find interesting the following analysis which fits in nicely with your long term optimism. It was originally posted by blizzard 44 on the RB Q board. I don't know the source. However, I find the analyis compelling for the long term. Here goes:
The cellular communications industry is often looked at in terms of "generations" of service deployment. First-generation wireless communications was marked by the coming of analog cellular telephony during the 1980s. Then, during the mid-1990s, 2nd-generation (2G) wireless communications services, better known as digital wireless, began to proliferate. As digital services evolved, based primarily on networks and handsets using one of three competing protocols, GSM, TDMA, and CDMA, costs decreased, the quality of voice transmissions increased, and new value-added services, such as caller ID and two-way paging, were allowed. However, although CDMA offered some incremental benefits when compared to GSM and TDMA in terms of voice quality and cost, both a result of its more efficient use of frequency spectrum,the difference wasn?t large enough to have any effect upon either the purchasing decisions of many carriers that offered wireless services, and only had a minor effect on the wireless users who were given the option to choose between two carriers each offering services based on a different protocol, as there was usually more than enough spectrum to go around in many regions. Meanwhile, since GSM and TDMA had greater support among international standards bodies and equipment manufacturers, and since Europe, the region with the highest penetration rate for wireless subscribers, had chosen to shun all protocols save GSM, going into 2000, only about 10% of all worldwide wireless subscribers used a CDMA handset.
However, this is set to change, as the cellular communications industry now makes the transition to third-generation (3G) services which will allow both far cheaper digital voice communications and a whole slew of services such as the following:
1. Spectrum usage efficient to the point that wireless voice services can be offered at prices low enough to convince millions of individuals, especially those not living in North America, in places where local calls cost money, to give up using their fixed-line telephony services altogether.
2. Advanced personal digital assistant (PDA) software on a handset (i.e. calendar management, phone and e-mail lists, etc.), and the ability to synchronize such software with information uploaded onto the internet via a PC.
3. High-speed internet access, giving carriers the ability to provide subscribers content such as news, weather reports, and streaming video, as well as services such as e-mail, instant messaging, videoconferencing, online trading, and corporate database access.
4. High-speed communications between devices in close proximity to each other via an open standards protocol known as Bluetooth, allowing these devices to exchange vast amounts of information in a convenient manner.
5. The installation of chips allowing cellular data communications on devices other than wireless phones. Such devices include, but aren?t limited to, PCs, PDAs, laptops, handheld video game consoles, digital cameras, and automobiles.
Unlike 2G voice services, 3G data services based on competing protocols won?t be equal, with the inequality favoring those offered via CDMA. Since a data packet can take up 50x as much spectrum as a voice transmission, the issue of efficient spectrum management matters tremendously in regards to affecting the cost of the data services provided by a given carrier. In this regards, not only will 3G variants of CDMA, known as W-CDMA, cdma2000, and HDR (technically, HDR's not a 3G service, as it can be used to provide 3G-quality data services alongside 2G voice services), allow data to be transferred at a fraction of the cost of their GSM and TDMA competitors due to their ability to send a data packet using as little as 1/9 as much frequency spectrum as their rivals, they?ll also able to do so at much higher speeds (2 mbps for W-CDMA and cdma2000, and 2.4 mbps for HDR, the latter of which expected to be available by 2001, as compared to 384 kbps for GSM and TDMA, set to come to market in 2002). As a result, CDMA has been accepted by all major wireless standards committees, European ones included, as the cornerstone for the deployment of 3rd-generation wireless communications services, and it?s very possible that within several years, the percentage of wireless subscribers using a CDMA-based service may be five to six times higher than the percentage doing so at this moment.
No company stands to profit more from the coming boom in 3rd-generation CDMA services than Qualcomm. Through dozens of patents the company filed during the early 1990s, it?s literally impossible for any company to create a CDMA-based product without first obtaining a licensing agreement from Qualcomm. Taking advantage of these patents, Qualcomm requires that any company that wishes to sell either CDMA handsets or the chips that functions as the microprocessors for these handsets, known as a CDMA ASICs, pay them royalties based on a percentage of the price of the handsets and ASICs they sell. The actual percentage Qualcomm collects in royalties from handset and ASIC manufacturers varies per licensing agreement, although the company?s stated that on average, its fees are between 2.5%-5.5%. These royalties generate a stream of nearly pure pre-tax profit of anywhere from $3-$15 per each of the millions of CDMA handsets sold.
Qualcomm has also been able to utilize its tremendous expertise in working with CDMA to become the undisputed leader in the market for CDMA ASICs. Currently, Qualcomm?s latest chip, the MSM 3100, offers significant advantages over the offerings of competitors such as LSI Logic and DSP Communications (acquired by Intel) in terms of processing power, data transfer speeds (64 kbps as compared to 14.4 kbps for competitors), power consumption, and the amount of voice traffic that can be handled over a given amount of frequency spectrum. It?s expected that competitors won?t be able to catch up to the MSM 3100 until 2001, and by then Qualcomm is set to release the MSM 5000, which contains a dual-processor architecture for greatly increased computing capabilities, and will be the first chip to allow full-fledged 3G voice and HDR data services. Qualcomm?s lead in the CDMA ASIC market, which it now controls over 90% of, has grown so large that even Motorola, which was previously determined to develop its own CDMA ASICs for its handsets, is now buying from them. Nokia is now the only major handset manufacturer still using in-house CDMA chip designs, and by the end of 2000, Qualcomm believes that they may be a ASIC customer as well. Furthermore, through its CSM line, Qualcomm also dominates that market for chips used in CDMA base stations, although the size of this market is only a small fraction of the size of the market for Qualcomm's MSM chips.
In 1999, roughly 40 million CDMA handsets were sold, an increase of nearly 200% from 1998. This compares to handset growth of only 70% for the entire wireless communications industry. Qualcomm CEO Irwin Jacobs has estimated that CDMA handset shipments will rise by 75% in 2000 to 70 million, but also stated that this number may prove conservative. Considering that total cellular handset shipments are still expected to rise by 60% in 2000, that CDMA is taking considerable market share in every region where it?s been allowed to compete (North America, South America, Japan, South Korea, Australia, and now China), and that the boom in CDMA-based wireless data services will show its first effects via 64 kbps internet connections, to call that number conservative is a major understatement. A much more rational estimate would be for handset sales to double to 80 million, although this number may also prove to be too low.
In Q4 ?99, roughly 16 million CDMA handsets were sold. Had Qualcomm been able to collect royalties not only for handsets sold by third parties, but for those produced by their handset division, something they?ll be able to do in 2000 as a result of the sale of the division to Kyocera, assuming a 38% tax rate, which is what they?re set to pay in 2000, the company would?ve generated $110.4 million in profits from royalties. Based on this number, assuming that 80 million handsets are sold in 2000, and assuming that handset ASPs drop by 10%, leading to a proportionate drop in royalty fees, Qualcomm?s 2000 post-tax royalty profits will total $552 million.
Meanwhile, the average selling price for the company?s ASICs during this quarter was $23.65, down from over $30 in the year-ago period. ASIC ASPs are expected to drop again in 2000, but by 15% at the most, and in spite of the drop, pre-tax profit margins on chips are expected to rise from their current rate of 36%. Assuming that a 15% drop in ASPs takes place, that the division?s profit margin rises to 40%, and that 72 million, or 90% of all CDMA handsets that I estimate to be sold next year use Qualcomm?s ASICs, this division will bring in another $359 million in post-tax profits. If base station ASIC sales account for 3% of handset chip sales, this will add another $10.8 million in profits. The company should also see gains from the sale of systems and design software which, based on Q4 ?99 numbers and 2000 chipset sales estimates, should bring in an additional $16 million in profits. Finally, assuming that the company?s other businesses, the largest of which are its OmniTracs truck fleet management equipment and Eudora e-mail software, which combined grew roughly 30% annually last year, grow profits on average by 5.5% sequentially (23% annually) each quarter from Q4 ?99, these businesses will add $188 million in profits. Combining the estimated 2000 profits for all of these businesses results in an estimated net income for Qualcomm of $1.13 billion in 2000.
It's very likely that CDMA handset sales will rise at least 87.5% from 80 million to 150 million in 2001, still a conservative estimate given that 3G and HDR services will first begin to be offered this year, leading subscribers to begin upgrading their phones at a faster pace than before. It?s also very likely that both handset and ASIC ASPs will rise in 2001 due to the complexity of the MSM 5000, and due to the likelihood that consumers will purchase more expensive handsets in order to have advanced internet/PDA features, but just to be safe, for now I?ll assume that all ASPs remain flat. Based on these estimates, assuming that profit margins rise slightly due to increased operating efficiencies, partially offset by slower growth in the company?s OmniTracs and Eudora businesses, Qualcomm should earn $2.1 billion in post-tax profits in 2001. This estimate is assuming that licensing fees generated by the sale of equipment related to HDR, which is set to be used to provide internet services on PDAs, laptops, and PCs as well as cell phones, will have no effect on its bottom line in 2001, a prediction that has a good chance of not holding up.
At the end of 2000, Qualcomm will be valued based on 2001 estimates. Assuming that Qualcomm?s expected growth rate for the next several years will be 70% by then, and factoring in the potential of a market correction resulting in valuations coming down slightly, it would make sense to set a year-end price target for Qualcomm based on 110x its estimated 2001 earnings. Amazingly, doing so shows that even after the unbelievable run-up it?s had, shares of Qualcomm are still relatively undervalued when compared to other marquee tech issues, for if Qualcomm were to trade at 110x my 2001 earnings estimate of $2.1 billion by year?s end, it would then be worth $231 billion, or $324/share.
This may only be he beginning. It's estimated that by 2004, roughly one billion handsets will be sold. With the possibility that 60-70% of them could be based on CDMA, and that handset ASPs may be much higher than today, as cell phones begin acting acting as the portable, handheld computers futurists have been envisioning for decades, Qualcomm could easily become the world's most valuable company just from profits stemming from its cell phone-related businesses. Of course, there's much more to Qualcomm than this: over the long run, millions of laptops, automobiles, PCs (in areas where cable modem services won't be available), and even watches will have CDMA chips generating a steady stream of profis for the company.
The wireless data communications/computing industry at this moment, in its early, immature form, looks much like the PC industry during the mid-to-late '80s, the time when the device was first beginning to proliferate into the consumer market. By having a monopolistic position regarding the ownership of the designs needed to make these wireless devices run, and by dominating the market for the chips that power these devices not via any monopolistic power, but through sheer engineering expertise, Qualcomm doesn't remind me of a young version one of the two companies that have come to embody the PC industry as we currently know it, but both of them rolled into one.
Note: This recommendation will probably be replaced at some point the future. Also, as with my other write-ups in which I estimate a company's future earnings and set year-end share prices, for me to call these estimates anything other than crude would make me a politician.
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