Phone.com (PHCM) Project Hunt Report--Part 2
Have they crossed the chasm?
Yes. Although it is unclear, still, how much revenue this will produce, and how big the ultimate market is. The browser will generate little revenue, but revenues have begun to ramp up on the server side. Companies that announced this year they will use the server suite have started to complete deployments, and individuals have started to buy phones with the browser installed. The key question, therefore, is whether the market is ultimately large enough to qualify as Gorilla-sized? That is discussed below.
Have they entered the Tornado? Is there hypergrowth?
Yes. Per the previous question, it's unclear how big the market is. At the least, one very large bowling pin is now falling. In the last year the company has made over 60 announcements of companies selecting the UP.Link server suite for deployment. It takes time for revenues to develop from a company's selecting UP.Link. The license is based on (1) subscribers added to the system, or (2) amortized over the period of a license agreement (12 to 30 months), depending on the type of license. This is a case where the tornado--if it is one--will be in place before it is recognized in any financial statements.
The company has stated that browser-related revenues will not be a major part of their revenues going forward. Certainly, year-to-year comparisons are very favorable, but that is largely because last year's numbers were so small. It appears that revenue ramp-up will be constrained somewhat by the partially service-dependent business model. It is not a pure software model, where there is virtually no cost or effort required to produce an extra few CD's. Not all additional revenues will flow directly to the bottom line.
OTOH, the handholding costs tend to be bunched in the beginning quarters, of installing server software and getting the telco customer's people up to speed with the product. Once this initial period ends, costs drop somewhat just as revenues from the telco start to accelerate-as more WAP-enabled phones get into the telco's customers' hands.
TRFM (p 176) says, "A good signal to begin tornado buying is when trade magazines stop printing articles questioning the readiness of a new technology and start printing ones focused on who is the emerging market leader." By this guideline, it seems that we're in the tornado. The articles over the last 6 months or so have consistently focused on who are the participants, apparently assuming that the market is here.
Corollary question: Is PHCM at the center of the tornado?
They sure seem to be. They are totally focused on developing software according to the WAP standard for wireless devices. They are the only company with this sole focus. PHCM Management believes they have an inherent advantage, given their focus, of being able to develop and implement software solutions on time to allow quick development of the next iteration of wireless phone. They are able to pass this advantage along to their telco customers.
Second corollary: Is the tornado large enough to support a Gorilla-or are we talking Shiny Pebble here?
This is a Gorilla-sized market. The reasoning: In the quarter, PHCM generated $35 MM in license revenues (half of which remains "deferred") on an increase of 1.3 MM phones among PHCM's clients. This demonstrates (for the first time?) the ability to generate license revenues from data subscribers. PHCM's licenses will compound as:
(1) the number of cell phones worldwide continues to climb,
(2) digital phones represent an increasing percentage of total cell phones,
(3) WAP-enabled phones penetrate the total of digital phones,
(4) PHCM is able to generate additional revenue per subscriber by adding other services such as MyPhone, OnBox, etc.,
(5) The depth of services leads to increasingly heavy use of the service by subscribers, driving the telcos to pay PHCM to add server capacity (which is the basis on which PHCM earns much of its license revenue), and
(6) PHCM solidifies its early lead in market share through the maturity and breadth of its product, and further products in the pipeline.
Which leads to some order-of-magnitude type projections. The number of WAP-enabled phones is presently a miniscule percentage of total cell phones (e.g., 6MM out of hundreds of millions). Researchers predict something like 1 Bn total cellphones in use at the end of 2003. (Separately, Alcatel has stated that they plan to build 10 MM phones this year.) David Hayden, of Mobile Insights estimates that 75% of mobile phones will be internet enabled going forward. That translates into 750 MM internet phones by year end 2003. Hayden also predicts that internet phones will be ten times the volume of handhelds such as Palm; while PHCM has licensed its software to Palm, this will not represent its central revenue opportunity, It will help of course. Parrish of PHCM states, "What is clear and generally accepted is that the number of people accessing the internet from phones will be larger than those accessing from PC's."
Given today's quarterly "revenues created" of $35 MM, we have an annual license run rate of $140MM immediately. Ramping from 6 MM phones out right now, to 750 MM, we multiply revenues one-hundred-fold, and can foresee a multi-billion-dollar revenue company. Of course,
(1) that ignores pricing pressures,
(2) it's only and order-of-magnitude estimate (if it can even be called an estimate-the numbers are so rough), but
(3) it also ignores provision of additional, richer, and profitable, value added MyPhone-type services that are only just being rolled out.
The size of the opportunity is in an order of magnitude equivalent with other companies with claims on Gorilla/King status:
Oracle sales $10.2 Bn, market cap $195 Bn,
Siebel sales $800 MM, market cap $20.7 Bn
Veritas sales $700 MM, market cap $36.1 Bn
Phone.com sales $140 MM market cap $ 4.0 Bn
(Sales for 1999, except PHCM, which is a Y2000 estimate. Mkt cap as of April 24).
Up to several weeks ago, there was some talk that valuation doesn't matter. Given the recent market, we all now know better. (And Mike Buckley always knew it). One of the problems here is that we cannot make a reliable attempt at estimating forward profits. We can say that our rough estimates support 10-bagger potential.
Investment Concerns
1. Geoworks has claimed royalties on its contribution to the WAP consortium. It muddies the issue of whether WAP will be proprietary or not. WAP was described as an open standard. Is it non-proprietary or owned by the WAP members? And, if it is owned by the WAP members, how do they own it, and do they end up with royalties as a result? Or, do we end up with a spitting contest among the WAP members that distracts them from their primary mission?
2. What about the lockup period? It ended a couple months ago, and there have been a significant number of insider sales. These of course have been above today's price level. The lockup expiration has contributed to the weakness in PHCM's stock, imo, beyond the decline caused by the market. This should be about over, alleviating that drag on the stock's price.
3. Will their model transfer into gorilla-type revenue streams? (This is actually a much more specific question than it might seem). Remember from the FM that the ideal tornado product is essentially a shrink-wrapped commodity. The Gorilla product will ideally have the "whole product" provided by other suppliers. From the 10K-PHCM contracts with the wireless providers to help install their server software, and to have their browser included in the phones. They also agree to provide technical support. There is a high level of customer support needed during the initial development period. Will PHCM be able to ramp up personnel count fast enough if they have to hand-hold their customers? We've addressed this in part above, in our Tornado discussion. We believe implementation support needs will follow the Oracle model.
4. Can PHCM succeed in a broadband world? WAP is supposedly optimized for the narrow-band environment. But, 5 years or less from now the wireless internet tornado will be centered around broadband, HDR-type access. What happens to WAP and PHCM when this happens? Will a later generation WAP protocol be backward compatible? Management has indicated that they are very focused on being in a position to make this transition from a position of strength. First mover status in the present generation should give them a great advantage in the next generation deployment, particularly if the second generation standard (WAP 2.0) is backward compatible-which the telcos will likely insist on. Second, management is working to ensure that they are in the lead in defining the WAP 2.0 standard, and in developing for the standard. And, third, we believe that adoption of data over 3G may not be as sudden as some think for non-PC users. Wireless phones and PDA's have a built-in limitation of their screen size. With the very small screens that will likely continue to exists in all pocketable devices, there just isn't that much need to drive a lot of data from the server to the handset. There's simply no place to display all that information. And, in these pocketable devices, there's just not that much room to store the information in the handset. (With a bow to Ausdauer and his Sandisk CompactFlashes. Will the cost of flash come down that much to make it practical to put lots of it on all the cellphones they'll be producing? We see that coming on in the second half of the decade, perhaps.).
5. Will the ERICY/NOK/MOT tri-opoly abandon or freeze out PHCM in further developments-such as they did with their recent announcement of a wireless e-commerce initiative? Can PHCM continue to win the majority of implementations, in the face of Ericsson's and Motorola's and Nokia's developing competing server products? They've been the leader so far. In the recent conference call, they were able to point to the maturity of their product set, the available value added features of MyPhone, and the development pipeline as non-price factors that have enabled them to win the bulk of competitive situations to date. The Telital success is very significant in this respect, especially for the GSM world.
6. Is this a Gorilla Game or a Royalty Game? It's both! (Now, there's an assertion designed to start an argument!) The first battle is WAP vs. other alternatives. PHCM's role with WAP makes this only a royalty game. The issue is not whether WAP is the Gorilla play. It isn't. The issue is the applications being written for WAP by PHCM-are they proprietary? Yes, they are. The question is whether PHCM can gain a sufficiently large installed base, with a sufficiently deep whole product, that the bulk of independent developers will write for their platform, using their developer kit (UP.Sdk). Will application developers write optimally for UP.Link and other PHCM applications? Does UP.Sdk have a look and feel distinct from other server developers' developer kits? (I assume, but have not confirmed that the other three have developer kits-can someone confirm this?) Does UP.Sdk give developers for PHCM's apps an advantage in speed or features that will lead them to prefer its environment?
An Aside: We tend around here to focus too much on Intellectual Property Rights as the sole criterion for determining pongids. The FM in fact includes a number of other criteria, and focuses most on value chain as the great determiner. WAP applications are an example of value chain being of primary importance.
7. Can they make money? Yes. This is a software model, in which the largest provider can spread development costs over the highest number of units, and in which there is less incremental cost per unit sold. Their position of strength today will begin to translate into increasing revenues over and above added costs. Because of the large amortization charges, we won't see GAAP profits for years, so the focus should be on internal cash flow.
Web references:
A good, recent third party article on status:
wirelessweek.com
Background on CEO Alain Rossmann:
salon.com
An interesting interview with the CEO (scroll to lower half of page):
redherring.com
There have been a lot of insider trades recently, related to lockup expiry:
biz.yahoo.com
mercurycenter.com
The WAP forum is an important information source:
wapforum.org
Fiscal Year end is June 30, so the 10K is a little dated, now:
freeedgar.com
And even the 10Q is 2 months old, which in this environment is a long time:
freeedgar.com
The company does put out a good press release on earnings, and that is more current:
biz.yahoo.com
They also publish their conference call to the Web, available on RealAudio:
corporate-ir.net
Conclusion
Phone.com appears to be building a strong value chain with barriers to switching. It appears to be in the center of an early tornado, increasing it's lead in market share. We see it as having a good chance to become a Gorilla due to wireless network operators scrambling to use a platform for WAP and the thousands of developers using the UP.SDK.
PHCM's market cap, at the time of this writing, is $4.0 billion. A Gorilla realm, as opposed to a niche, would suggest that there is room to grow to a $100 million market cap scale company. It is too early to confirm that PHCM can justify that kind of market cap. For that to happen, (1) WAP must emerge as the standard for wireless internet. That is happening. Game over. (2) PHCM must emerge as the key player in the WAP world, with leadership positions in both the GSM and CDMA worlds; they are definitely in the running here, although it's still early. The Telital win is very important as an indicator, and they need further wins in GSM. (3) Profitability cannot be taken out of the market. That risk is minimized by the combined proprietary positions of the WAP Forum members, and by constraints on MSFT. (4) Extensions to the revenue stream must be developed. PHCM is doing this by encouraging specialized applications (examples: Horse wagering, Ticket Master), and by putting themselves in position as the major Application Service Provider for wireless applications, through MyPhone and related acquisitions).
PHCM's risk/return formula is a lot better today than they were a month ago. Today, they can satisfy Mike Buckley's goal of becoming a10-bagger. This is such a fast-moving area that they remain more risky than an ordained Gorilla. When John started this report, back in February, the stock was running up toward the 150's (it eventually hit 208). Now, 2 months later, PHCM has reported some very significant and positive developments, including last week's quarterly numbers. But their stock has now dropped to below 70. The risk has lowered, while the potential has risen. The risk/reward picture has improved. It is a Gorilla Candidate on sale, and with this quarter's license revenues, it's no longer just a story stock.
Disclosure: Following the quarterly report, John reestablished an initial position in this stock, at 67 7/16. Susan has not taken a position in Phone.com-She bought too many stocks in February and March and doesn't have any she wants to sell now. She says that if she had extra cash, it is the stock she would be buying. |
