Gregg Powers, a webnapped investor in Qualcomm said [at CDMA Forum]:
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Setting aside recent stock market volatility, I would suggest that Qualcomm's stock is caught in a nether zone as it transitions from a research-driven, engineering-centric company to a commercial manufacturing enterprise. Until recent quarters, Wall Street treated QCOM as an event driven concept stock, with price appreciation and/or depreciation deriving from sound bites relating to CDMA's pending commercialization. For example, the stock hit an all time high last year when Sprint and PCS PrimeCo selected CDMA.
With commercialization occurring around the world, and subscribers passing the million mark, the investment issue is no longer whether the technology will work as advertised, or whether it will scale up, or whether it will provide excellent voice quality and so forth. These issues have been settled empirically. Wall Street is now looking past the technology "ifs" and focusing on the earnings "whens". Said another way, Qualcomm now has to prove that it can generate material income from the CDMA franchise that it has created. Even for a long-term institutional investor like myself, who understands the company fairly intimately, earnings visibility is poor at this juncture due to a myriad of crosscurrents.
Let me give you some examples. Margins at Qualcomm Personal Electronics (QPE), the .handset joint-venture--are still very low due to manufacturing start-up expenses, high component costs (which are being addressed by second sourcing and volume purchasing) and other production inefficiencies. Moreover, the current phone is a structurally complicated design, so the company is currently working on a new phone (TGP) which should prove more efficient to produce in volume.
Put this all together and margins for QPE should improve steadily as the year progresses. This will have a magnified impact on earnings since expanding margins will be applied to greater revenue, creating substantial operating leverage. However, QCOM is also building a worldwide cellular infrastructure business, which to date has just two customers, Nortel and Hughes. Vast amounts of dollars are being poured into this segment against only minimal revenue.
Management justifies these expenditures by looking to the size of the world-wide market, and noting that if Qualcomm was clever enough to commercialize CDMA, it should be clever enough to carve out a successful infrastructure business. With the market size estimated to approach $400 billion over the next ten years, it's not hard to see the pot of gold. On the other hand, since vendor financing is a critical competitive differentiator, Qualcomm will need a strong balance sheet to compete in this world market. It is absolutely essential that the company generate sufficient earnings, with enough predictability, so that Wall Street will provide capital at a reasonable cost. This is just the tip of the iceberg and sorting through all the moving parts tends to give me a headache.
So suffice to say, investors need to understand the stakes, cut management a reasonable amount of slack and monitor the company's progress over the next several quarters. On the other side of the ledger, management must understand the mission criticality of EPS. Poor earnings equals a depressed stock equals an excessively high cost of capital equals an inability to provide vendor financing. Arrrggh, my headache is back.
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This vendor financing business concerns me. What it might imply is that either the customers don't have any money to buy what they want or they lack confidence in CDMA. Qualcomm and others are having to fund the development and provide performance guarantees.
I hope all it means is that the customer says: "Okay, we'll buy your CDMA system. Build it and we'll pay for it on completion." Which is a reasonable proposition. If that is the case, fine and Qualcomm will need big heaps of working capital to get production lines humming.
But if there is shortsighted financing concern at earnings per share, another way is to issue shares to raise working capital. Which is basically what they have done with NextWave Telecom - start an infrastructure wholesaler. Investors have backed Qualcomm to the tune of billions already. They are unlikely to blanch at the thought of investing in infrastructure production.
NextWave has still to do its IPO and needs to raise billions. With the rapid roll-out of CDMA, investors will be able to see that NextWave will be a good bet. |
