A Blast from the Past.
Sounds bad, Market Cap $1.5B, PE of 59 and five times sales. Must be a real dog.
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BLACK BOX BATTLE 10 April 1995
BY JAYE SCHOLL
Everyone, everywhere seems to be on the telephone. A skier calls Boston while riding a chair lift in Utah. A hedge-fund manager talks stocks to a caller from Los Angeles while he climbs his Stairmaster in a Manhattan gym. Beachcombers yak as they stroll. The cellular phone industry counts 25 million customers and is adding new ones at a rate of 28,000 a day. And now comes the next phase. It's called personal communications services, or PCS, and it will let the skier, money manager and the beachcomber send and receive faxes, messages, pages and electronic mail. The PCS industry envisions a customer having one black box/telephone, one telephone number, and the ability to communicate with anyone, anywhere-in short, turning the world into a wireless global village. While cellular phones may have ruined the ambience of a few dinner parties, PCS could render whole cities obsolete.
This next stage of the wireless communications evolution hasn't arrived in the U.S. yet. But Wall Street is anticipating it in the customary way by throwing money at companies that can lay claim to a piece of the emerging PCS technology. One of these companies is Qualcomm in San Diego.
Qualcomm has developed a technology involving Code Division Multiple Access -mercifully abbreviated to CDMA -for use in a variety of digital wireless communications systems, from cellular phones to satellites. Although Qualcomm has some money-making operations, it's the application of its proprietary CDMA technology to the emerging PCS industry, and to a lesser extent, the existing cellular industry, that has generated speculative excitement.
All alather over the possibilities of CDMA, Wall Street has placed a cool $1.5 billion market capitalization on a company that earned $27 million, or 52 cents a share, on sales of $294 million in the 12 months ended Dec. 25 (its fiscal year ends Sept. 30). At $30.25 a share, its price last week, Qualcomm trades at a lofty 59 times earnings and more than five times sales.
Buoying these valuations is the hope that Qualcomm's CDMA technology will make a convincing show in test runs for cellular phones in Los Angeles this summer and later this year in Seattle. And in Toronto this summer, Qualcomm's CDMA technology will go head-to-head against a competing PCS technology called DCS 1900.
Qualcomm insists that repeated field trials have demonstrated that its CDMA technology works better than competing technologies, offering higher carrying capacities, better voice quality and better privacy. And it hasn't taken kindly to those who disagree, as Bruce Lusignan, an engineering professor at Stanford University, can attest. In 1992, Lusignan declared Qualcomm's CDMA technology unworkable at densities claimed by the company, a conclusion he reached after riding for a couple of hours around San Diego in a Qualcomm-equipped van and speaking with researchers. Qualcomm and its lawyers responded with threatening letters to Lusignan, and later, to the dean of his department, in an effort to stifle his criticisms. It didn't work.
But even if Qualcomm's success in Toronto, Los Angeles and Seattle silences its critics, it is by no means assured of commercial success. The road to technological dominance, after all, is littered with better mousetraps that failed to get to market on time. And for the PCS industry, timing is crucial.
In the U.S., the industry jumped from the theoretical to the practical in December when the Federal Communications Commission auctioned licenses to use part of the radio spectrum for wireless services. The bidding was intense, with 21 communications groups shelling out a total $7.7 billion for licenses. Having paid so much money, and fearful that existing cellular phones will be upgraded to compete with PCS units, the communications consortia are eager to launch PCS service as soon as possible.
They estimate that it will take 18 months of tests and debugging before they can offer PCS commercially. That means signing up suppliers of the telephone units, called handsets, and the manufacturers of the infrastructure. But which transmission technology should they choose?
The FCC, in its continuing effort toward deregulation, has decided to let the marketplace be the arbiter of the best standard for PCS transmission. As a result, Qualcomm's CDMA technology is in white-hot competition with other digital-based systems. One is a U.S. version of Time Division Multiple Access (TDMA). The other is the aforementioned DCS 1900, a derivative of a European TDMA technology called GSM -short for Global System for Mobile Communications. GSM has been selected as the standard in Europe.
Qualcomm has granted licenses to numerous communications companies to equip their products with CDMA technology. In return, these manufacturers will pay royalties to Qualcomm. But as Qualcomm concedes, it has no control over the amount of money and effort its licensees will devote to developing CDMA products.
"To date," rather plaintively notes Qualcomm's most recent 10-K filing, "to the company's knowledge, none of the company's licensees has manufactured CDMA equipment in commercial volumes, and significant software and hardware development must be completed before they will be in a position to deliver commercial quantities of CDMA network or subscriber equipment to their customers." If CDMA equipment isn't available in time for PCS applications, Qualcomm cautions, "PCS service providers may elect to implement other technologies, such as DCS 1900, for their PCS operations."
This may be on the near horizon. GTE, the country's largest independent telephone company, is still leaning heavily toward CDMA "But there's the question of availability ," declares William Pallone, general manager of PCS operations at GTE. "We are looking at alternatives and will make a selection within 60 days."
More devastating would be the defection of PCS Primeco, a four-way partnership of AirTouch Communications, Bell Atlantic, Nynex and
US West. PCS Primeco was one of the big consortia that participated in the government auction in December, and spent $1.1 billion for PCS licenses in 11 major cities. Until now, the assumption was that PCS Primeco would select CDMA -certainly, that's a key assumption investors have made in placing so generous a value on Qualcomm. With its coast-to-coast alliances, PCS Primeco has enormous clout in establishing a national PCS standard.
But in order to get PCS Primeco's business, CEO George Schmitt is demanding that the CDMA manufacturers sign written guarantees that they can supply a working PCS system, with telephones, in 18 months. If they don't deliver, they would be liable for penalties.
Schmitt had to delay launching a digital cellular system in Germany because manufacturers were months late in delivering telephones. He swears he won't make the same mistake twice. "I know people are saying I'm being tough," barks Schmitt. "But what am I supposedto do? Go out and tell my customers in 18 months, 'Sign up for PCS, but hey, we don't have any telephones yet?' I'm not putting my career on the line like that, and I'm not jeopardizing my shareholders."
If he doesn't get signed guarantees that include telephones, Schmitt warns, he will consider "other options" -in other words, TDMA or DCS 1900, the U.S. derivative of GSM, the standard that has been adopted across Europe. "I'll make a decision in a couple of weeks," he vows.
People with firsthand knowledge of the negotiations say manufacturers would sign the guarantees if they didn't include telephones. That's because the phones are supposed to be equipped with semiconductor chips supplied by Qualcomm. But it hasn't yet produced a chip for the PCS phones that will include the 13-kilobit voice coder -a feature that enhances voice quality on wireless transmissions.
Manufacturers don't want to be on the line for something they can't guarantee.
Qualcomm maintains that its CDMA telephones with the 13-kilobit voice coder will be ready, but the manufacturers bidding for PCS Primeco's businesses want more than assurances.
Qualcomm finds itself in a kind of technological version of the-chicken-or-the-egg. For its technology to prevail, it needs the likes of AT&T, Motorola, Northern Telecom and OKI Electric to finance and manufacture its equipment. But those companies are understandably reluctant to make CDMA-based equipment until they receive orders from cellular and PCS providers. And those providers, whose ranks include PCS Primeco and GTE, are less than eager to order CDMA-based equipment if they're not convinced it will work.
Given that it can't force its licensees to make CDMA-based products, Qualcomm has taken on a bigger role in getting the technology out of the lab and into the store. Research-and-development costs jumped 80% from $27.4 million to $49.6 million in fiscal 1994. What isn't clear is whether that expenditure, representing a staggering 18% of revenues, demonstrates Qualcomm's faith or its desperation.
Moreover, not only is Qualcomm powerless to compel manufacturers to devote their resources to CDMA, it's also unable to prevent them from working on competing technologies. As Qualcomm notes in its December 10-K, "several major equipment suppliers have made substantial investments in TDMA technology and
have begun production of TDMA-based equipment for the U.S., including AT&T, Motorola, Northern Telecorn and OKI Electric, all of whom are licensees of the company."
Ditto GSM. Last week, Northern Telecorn, part of BCE of Montreal, received a $100 million, three-year order to build GSM-based equipment for wireless networks in the Carolinas and eastern Tennessee being installed by BellSouth. Yet in one of its most significant alliances, Qualcomm in December had signed a series of agreements with Northern Telecom for the "design, development, manufacture and sale of CDMA infrastructure equipment" for worldwide installation.
While nothing in Northern Telecom's arrangement with BellSouth precludes it from continuing its work on Qualcomm's CDMA technology, logic suggests that Northern Telecom's manufacturing energies would flow to the demand.
Like tech companies in general in the past couple of weeks, Qualcornm's stock has been weakening. It's down from its high of 35 1/4 a share at the end of March and closed at 30 1/4 last Friday. But the pressure on Qualcomm's shares has been intensified by, among other things, news of GTE's possible defection and concerns voiced by PCS Primeco.
Qualcomm, in the persona of Molly Foerster of investor relations, shrugs off the perceptions, the defections and the price break in its shares. "We're not worried about GTE and its possible selection of another technology for PCS," which, she says, would probably be temporary. "GTE works closely with us, and we understand that it is fully behind CDMA, which is the technology it has chosen for its cellular system."
As for PCS Primeco, Foerster professes a similar lack of concern: "We and the rest of the industry are confident thatwe will have commercial CDMA equipment ready by the time Schmitt needs it." But as Schmitt has made clear, he's not looking for statements of confidence. He's looking for signed guarantees, and he wants them soon. So far, he hasn't got any.
Lusignan, who directs Stanford University's Communications Satellite Planning Center, remains a skeptic of Qualcomm's technology. Nothing has happened in three years to make him change his earlier conclusion that Qualcomm cannot deliver on its promises. "They continue to delay their offerings because the problems they have can't really be solved in a way that makes them as efficient as others," he says. Nor have Qualcomm's saber-rattling letters to him and his dean made Lusignan shy about voicing his opinion. "I feel universities need to be much more recognized as sources of objective opinion. Any attempt to interfere with that source leads companies and investors to waste their money." |
