Qualcomm (by Fredhager.com Staff Researcher, Eric Jhonsa)
What's going on with Qualcomm is all too typical given the investment mentality most Wall Street types have traditionally brought to the table. The stock's recent collapse can almost completely be related to some highly unnecessary, poorly grounded uncertainty permeating the market's opinion of the company's long-term potential. If the individuals on the street driving this sell-off thought and acted rationally, then this uncertainty wouldn't be a problem. Unfortunately, as intelligent as many of those who work there may be, Wall Street has an irrational hatred of uncertainty.
This hatred of uncertainty is something that's entrenched into the history of the Street. The investment banks, brokerage houses, and asset management firms that run this nation's financial services industry are, by and large, very conservative. They manage billions of dollars for some very rich clients, and the primary goal of the majority of these clients isn't to become rich, as they already are wealthy, but to stay rich. Any good business will always try to do its best to give its customers what they want, and most of the largest customers of these firms seem to prefer security rather than growth. Thus analysts and fund managers are trained to keep this in mind when making their investment-related decisions.
As a result, while analysts and fund managers are more than willing to both recommend and buy into volatile high-flyers from time to time, they'll only do so as long as they catch nothing but good vibes on such companies from all sides. They'll only do so as long as a given high-growth company's stock is taking out old highs every other week, as long as its earnings estimates are getting shattered every quarter, as long as new product announcements, smart acquisitions, and major contract signings are the rule rather the exception for each and every month, and as long as half of all the pundits in Forbes and talking heads on CNBC are singing the company's praises. If these guys see something that makes them think that the given company might not be an unblemished work of art, they'll flee from it the same way elephants flee from mice. Not even, actually. I think an elephant would start running only if it saw a rodent come up before it, but wouldn't do so out of fear that one might come up on the horizon, although there's no way of knowing for sure. Many of these folks tend not to have even that level of courage.
Needless to say, the elephants of Wall Street are ditching Qualcomm out of fear that, metaphorically speaking, a mouse is on the horizon; and it's nothing new for the company. Although those that have only recently found about Qualcomm might not be aware of it, back in 1997-1998, while its high-tech brethen happened to be soaring to the heavens, the company's stock was highly earthbound. This took place in spite of the fact that it was posting some phenomenal growth. Throughout those years, its P/E kept dropping, and at one point almost reached a ridiculous 20. Why, you might ask? Because numerous pundits were worried that the third-generation (3G) international wireless standard wouldn't involve Qualcomm's CDMA, leading the technology to die a slow death. These people pointed to the fact that Ericsson, the world's leading wireless networking equipment manufacturer, didn't support CDMA at all, and was actually in a heated patent dispute with Qualcomm, and the support given to CDMA by Nokia, the world's leading cell phone manufacturer, was anemic at best.
Qualcomm fans knew better. They saw that although the majority of the world's wireless networks had chosen to run GSM, CDMA was far superior to GSM in regards to high-speed, high-capacity wireless data communications, and thus the rest of the world, Ericsson included, would forget about the fact that networks built on the former weren't compatible with the latter, and would adopt CDMA for 3G anyway. I doubt that this fact was lost on most of the power brokers who decided to shun Qualcomm. After all, there are some smart people working on the Street ("some" is an important word here). However, these people, given the caution that they tend to practice at all costs, decided that the huge potential return they could attain on
their investment simply wasn't worth the risk involved.
Then came the Ericsson agreement, ending the lawsuit and paving the way for CDMA to be the protocol of choice for 3G. Soon the same people who wouldn't touch shares of Qualcomm with the proverbial ten-foot pole couldn't get enough of the stock. By the time that the buying frenzy in the company had reached its zenith, claims such as Paine Webber Analyst Walter Pieczyk's "3 billion people each with 2 CDMA devices in 2010" (as optimistic as I am about the company's prospects, I have to admit that prediction was quite absurd) were the norm. Of course, even if they got in soon after the deal with Ericsson had been made, none of these people profited as much from the stock's manic appreciation as those who invested beforehand as a result of having the foresight to forget about near-term quabbles, and rather focus on the long-term need for CDMA in leading-edge wireless data solutions.
Now we're right back where we were in '97 and '98, not in terms of the price Qualcomm's trading at (we haven't fallen that far), but in terms of the way the street's viewing the company, and the uncertainty that's making these investors ditch shares of Qualcomm en masse; and let me tell you, it has almost nothing to do with the recent Korean news, the repeal of Korean handset subsidies, and it only indirectly has to deal with China Unicom's decision to stay with GSM for now. These three short-term problems are just excuses to sell. Think about it: if the street really believed that when 3G takes over the wireless world in a few years, that Qualcomm would be getting significant royalties on all 3G handsets, and that its chips would be in the majority of these handsets, do you really think that it would kill the stock the way it has over issues such as handset subsidies and Chinese rollout postponements? Of course not, which is why the true source of the fear and panic on the Street in regards to Qualcomm stems from a far more critical issue. So what is this issue? Well, it can be summarized in one little acronym: W-CDMA - a hot topic and cause of the latest downturn.
As I'm sure many of you already know, the specifications for W-CDMA, one of the two competing variants of CDMA that can be used by a wireless carrier to offer 3G services, weren't developed by Qualcomm, but by its good friends (note sarcasm) Ericsson, Nokia, and Japanese carrier NTT DoCoMo. These companies have done their best to use their extensive clout to make the underlying code that W-CDMA is based on have a lot of GSM-like attributes, and to make it the 3G protocol of choice for the majority of the world's wireless networks; and as much as I hate to say it, as long as these networks end up rolling out on schedule, it looks like they're going to succeed. So now we have this renegade variant of CDMA set to be the dominant 3G standard, a variant whose specifications weren't developed by Qualcomm but by companies that it's often been at odds with, which means that it might be more difficult for the company to extend its CDMA ASIC dominance (Qualcomm makes 90% of all CDMA ASICs sold); and to top it all off, Ericsson, Nokia, and Motorola, the wireless industry's "big three," still haven't signed official W-CDMA patent licensing agreements with Qualcomm, with all three companies, as well as a number of others, claiming that there are significant amounts of their own intellectual property embedded into the standard. So analysts and fund managers, in all too typical fashion, are now doing their best to stay away from Qualcomm in the same manner that they once did; but given the seemingly bleak circumstances, it would be difficult to blame them from doing so, right?
Well, let's separate fact from fiction. Just as it would've been a smart move for Qualcomm investors to cut through the hype generated by comments such as the one Pieczyk made during the stock's heyday, it's important to take a cold, impartial look at W-CDMA and what it implies for Qualcomm's long-term potential.
First, while Ericsson and Nokia will undoubtedly get some royalties for W-CDMA, and while major companies in the wireless industry may also receive W-CDMA royalties, by all accounts, it's virtually impossible for anyone, no matter how hard they might try, to create a working commercial version of CDMA without infringing on Qualcomm's patents. Furthermore, George Gilder has stated once that NEC engineers aiding in DoCoMo's W-CDMA rollout have confirmed to him that W-CDMA does involve the use of a large amount of Qualcomm's intellectual property, and Hitachi has already signed a W-CDMA licensing agreement with Qualcomm, one which stipulates that Hitachi will pay the same royalty rates for a given 3G product regardless of the technology it happens to utilize. Considering that no company as large as Hitachi would've signed such a deal without thoroughly evaluating the patent claims of the company it's dealing with, while it may still be a while before a number of handset and wireless networking equipment manufacturers sign the actual licensing deal, Qualcomm will still probably get significant royalties on W-CDMA product sales. Meanwhile, it should be kept in mind that Qualcomm has one very important strategic advantage in regards to its patent portfolio when compared to those of other companies: a working version of 3G can be created without infringing on their IP, but not without infringing on that of Qualcomm; cdma2000, W-CDMA's primary 3G competitor, utilizes the technology of no company other than Qualcomm. As a result, if Qualcomm feels that it's getting short-changed by Nokia, Ericsson, or anybody else, it can simply refuse to license its patent portfolio to them, stalling the rate of deployment of W-CDMA in the process. Thus, faced with the postponement of W-CDMA rollouts that they were planning on conducting via the handsets and networking equipment produced by these companies, with the exception of Europe, where the European Union's mandated that all wireless operators must use W-CDMA for 3G, these carriers could quickly lose business to operators deploying networks based on cdma2000 instead, a technology for which many other companies have already signed necessary patent licensing deals with Qualcomm. Although I seriously doubt that such a situation will manifest itself, and expect that Qualcomm will eventually get the favorable W-CDMA royalty agreements that it's seeking, this ability to allow operators to circumvent W-CDMA in areas other than Europe should give Qualcomm a key bargaining advantage.
Now to the question of whether Qualcomm will be able to extend its CDMA ASIC expertise into the W-CDMA market. The concern here stems from the fact that Qualcomm has little expertise with GSM, the technology by which, as stated previously, much of the underlying protocol for W-CDMA is built upon. However, by the same token, it should be noted that it's much easier for a company that's experienced with CDMA to pick up on GSM rather than vice versa. For example, consider how much trouble Nokia's engineers, who have proven extremely adept at creating GSM ASICs for use in their handsets, have had in regards to creating competitive CDMA chipsets when compared with those of Qualcomm. As a result, while Nokia has over 35% of the worldwide GSM market, its decision not to use Qualcomm's ASICs has resulted in its CDMA market share to be below 10%. This number may drop even further quite soon as both Sprint and Verizon, the two leading US CDMA operators, are on the verge of discontinuing the handset purchasing agreements they have in place with Nokia. One might argue that the real reason for Nokia's failure in regards to CDMA chipset design stems from the fact that the company, from the moment it began making forays into the wireless market, has always been focused on GSM, and that CDMA isn't their core competency. However, TDMA, another competing wireless protocol, isn't Nokia's forte either, yet unlike their CDMA debacles, Nokia seems to have no trouble whatsoever in regards to making quality, high-end TDMA handsets. The reason for this is that, in the words of one engineer, the technological differences between CDMA and other digital wireless technologies are as large as the differences between digital technologies and analog ones. The differences in the difficulty related to developing the technologies run along similar parallels. As a result, with the exception of Qualcomm, which pioneered the commercial use of the technology, every company that's attempted to do so, Nokia or otherwise, has had trouble developing quality CDMA chipsets.
On the other hand, by means of their ability to single-handedly create HDR, a time-division (i.e. similar to GSM) cellular technology, Qualcomm's demonstrated quite well its ability to learn new tricks. Combine that with the fact that in spite of possessing some GSM-like attributes, the technology it uses to make wireless voice and data transmissions over a network still makes W-CDMA, as the name implies, a CDMA variant, and you can see that although Qualcomm may face some major challenges in the W-CDMA ASIC arena, it still has to be considered the odds-on favorite to dominate this market, just as one had to consider CDMA the odds-on favorite to become the preferred worldwide standard for 3G back when Qualcomm was still fighting it out with Ericsson in the courts.
As I've tried to show, all of the pessimism currently being showered upon Qualcomm is nothing more than history repeating itself, with Wall Street's finest once again doing their best to add fuel to the fire of needless uncertainty regarding the company's potential. It all reminds me of a third-rate TV series where, in every episode, the show's primary protagonist ends up facing off against the same antagonists as before, and faces the same dilemmas as before, with only the setting and context of each episode being different. In these shows, it sure never looks good for the protagonist during the middle of the episode, and he always ends up hearing a chorus of concerned people telling him that it'll be impossible for him to succeed in his mission, all in a sad attempt to make the viewers of the show think that this time, the good guy really won't end up winning; but in the end, the only viewers who ended up having been duped were the ones who ended up buying into that repetitive, predictable commentary. |
