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Tero's Q&A Page
The view from Finland
The Ericsson-Qualcomm aftermath
By Tero Kuittinen, Guest Columnist
Last Update: 3:00 PM MT Mar 28, 1999
The short term benefits
Sighs of relief all around. The biggest winner of the Ericsson-Qualcomm dispute is probably Qualcomm - they could have
ill afforded a protracted legal fight and the deal finally rids the company of the disastrous infrastructure division. Losing the
network business entirely weakens Qualcomm's ability to influence third generation digital standard development and
probably affects the long term success of the handset division. The network technology evolves so rapidly that handset
development has to take place concurrently with infrastructure development. But Qualcomm's network business wasn't
robust to begin with - it was based mostly on selling base stations at a loss. The digital switch expertise that turned Lucent,
Ericsson, Nortel and Nokia into network powerhouses didn't exist at Qualcomm. After the deal was disclosed Wall
Street backed the "good riddance" view of Qualcomm network business enthusiastically. Qualcomm finally looks like a
focused company; licensing income, chipsets and handsets.
The benefits Ericsson derives from the deal are a great deal fuzzier and depend largely on how much leverage the
company gained in the 3G development. The immediate prospect of folding a loss-making CDMA network division into
Ericsson and launching an expensive CDMA phone project should be sounding alarm bells. Let's review some of
Ericsson's PR coups from recent months. After announcing the weak fourth quarter results Ericsson deftly moved the
spotlight from shrinking handset sales into the future by unveiling the new T18 handset. Then Ericsson used a huge Turkish
GSM network deal to mask a simultaneous announcement that their vaunted GSM/TDMA/AMPS phone will be pushed
into next year. Most newspapers fell for it; the network deal buried the product delay. More recently, the persistent
worries about the delay of T18 and continued market share losses have eroded Ericsson's stock price. Then came the
master stroke: Ericsson's first quarter profit warning was timed to be released just days before the Qualcomm deal was
announced. Once again, the bad news was lost under upbeat press releases.
Pure chance? Or skillful manipulation of Wall Street? Take your pick. Ericsson is now milking the CDMA manufacturing
angle for all it's worth - but like in some tacky horror movie, the mouldering corpse of Ericsson's 1999 profit picture is
going to claw its way to daylight, no matter how deeply the company is trying to bury it. It's not that Ericsson's long term
prospects are bad - the year 2000 handset line-up looks bright and a power position in W-CDMA development can be a
genuine boost for profits in 2002-2005. But it seems unlikely that Wall Street will swallow the string of bad 1999 quarters
Ericsson is poised to feed it. In contrast, Qualcomm's profitability is instantly improved by the deal. The CDMA division
Ericsson bought is notoriously weak. We caught a glimpse of just how much synergy exists between GSM and CDMA
network technologies after Motorola's attempt to leverage their GSM know-how into launching a CDMA network
business - the CDMA specialists Lucent and Nortel pretty much knocked Motorola out. The CDMA handset situation is
even more desperate. Nokia and Motorola are now invading the high end CDMA handset market after years of
preparation. I doubt that Ericsson's belated CDMA epiphany will result in much headway in either infrastructure or
handset markets.
Welcome to Spin City
The deal has plenty of real impact on the telecom industry - but as usual, the hype surrounding the agreement spun rapidly
out of control. The premise that Qualcomm and Ericsson will now have a genuine interest in collaboration and smooth
technology transfer is absurd. Vicious backstabbing, byzantine intrigue and outright slander - following the past relations
between these two firms has been like watching a rerun of "I, Claudius" without the orgy scenes. The ink on the agreement
wasn't dry when the companies already started to leak conflicting information on the specifics - Qualcomm hinting at high
licensing fees and Ericsson insisting that they were able to push the fees down considerably. I wouldn't take the word of
either party at face value until all the fine print has been deciphered.
The big issue concerning 3G is the one that few are willing to discuss. Is there actually a market? Will the consumers go
for handsets that cost around 1'000 dollars and weigh a lot? The Iridium project was based on the premise that people
will pay practically anything for a satellite phone, even if you can brain a bull moose with that lump of metal Motorola is
currently pushing. Consumers disagreed. The current "creeping" improvement of existing, second generation digital
networks is bringing the data transfer rate above 100 kbps with much smaller investments from operators. It's a long way
to 2002 when 3G solutions are expected to premier outside of Japan. Valuing a company based on 3G revenues is a risk
investors are assuming - not a one way bet.
The giddy media reaction to the deal seems slightly unhinged. The Wall Street Journal gushed over "short term benefits"
like multi-mode phones - apparently ignoring the fact that a GSM/CDMA phone is highly unlikely to surface before the
year 2002. GSM/TDMA phones that are much easier to produce are arriving next winter after several years of
development. And these two standards are kissing cousins technologically. Combining GSM and CDMA in one unit is a
monstrous challenge. The leading companies *can* build these kinds of models right now. But they couldn't sell them.
One consumer poll after another has shown that people are not willing to accept a substantial price or weight premium in
multi-mode phones. That's the reason Nokia and Ericsson are debuting GSM/TDMA phones only next winter - it's the
earliest they could come up with models that weigh under 150 grams and can be sold on US market under 300 dollars.
Risk
I'm not sure just how serious Qualcomm's hints at "expanding to Europe and China" are. In the long run, operating a
succesful handset business demands synergy benefits with the infrastructure side. Moreover, total lack of brand
recognition and distribution networks would make Europe and China fiendishly difficult markets to enter. There are no
examples of succesful handset companies that do not have a double digit global market share; Siemens, Philips, Samsung,
LG, Denso, etc. are not making any profit at handset manufacturing. The only exception is Alcatel, which seems poised to
enter the front ranks of mobile phone companies this year, largely at Ericsson's expense. And that success is rooted in
Alcatel's 30% market share in the phenomenally growing Mediterranean markets and a solid 10% on China. Meanwhile,
Qualcomm would do well to finish 1999 with 10% market share even in its US home base - not a good launch pad for
global expansion.
Qualcomm's share of CDMA chipset market in USA has topped 90% and has provided the company with a
near-monopoly position with all the associated benefits. That share is set to collapse in 1999 - Nokia and Motorola are
not using Qualcomm chipsets for their new CDMA phones. By next autumn Sony is also switching to non-Qualcomm
chipsets. The end result will be a rapid market share erosion for Qualcomm. Even more worryingly, leading American
CDMA operators are showing signs of embracing Motorola and Nokia as their preferred handset providers. Sprint is
elbowing Q-phone aside and positioning Startac as their top high-end model; Primeco is considering using Nokia 6185 as
their leading spring model. Qualcomm had several years to consolidate their position as the premium CDMA brand before
real competition arrived. That wasn't enough. What Qualcomm needs to do is to consolidate their position in the American
market; if they yield the 200$-plus market segment to Motorola and Nokia they'll end up with a very tough competitive
position in the future. The product cycle of this company is excruciatingly long. Apparently the new smartphone, pdQ, has
spent three and a half years in development when it finally debuts this summer. Launching a global expansion without a
solid home market showing would be the most likely risk for Qualcomm's future success.
Similarly, Ericsson's CDMA expansion is a chancy move. Being years behind competition is bad enough - but Ericsson is
also saddled with interminable product cycles. They have not kept up with GSM phone development with Motorola,
Nokia or even Alcatel. So where will the extra zip to catch up in CDMA phones come from? Qualcomm is so small that
they can use their licensing revenues to fund considerable R&D projects. Ericsson's licensing revenue from GSM and
CDMA patents is dwarfed by the sheer size of the company. While Qualcomm's handset profit margins have risen due to
lack of stong competition in the US CDMA handset market, Ericsson's margins have been eroded by going head-to-head
with their big competitors in the fiercely contested GSM market. I would think that Ericsson's near term risk of profit
problems is considerably higher than Qualcomm's.
Nokia now faces the prospect of Ericsson's hegemony in determining the future of third generation standard. W-CDMA's
position was strengthened by last week's deal - but it's no longer an ostensibly equal Nokia-Ericsson project. Ericsson
probably will get higher licensing revenue thanks to a cross-licensing deal with Qualcomm. They are also well positioned
to fine-tune the technical details of the standard to suit Ericsson better than other companies. The CDMA2000 looks
embattled. Now the development of this standard rests mainly on Nortel and Motorola - both of which have considerable
investments in W-CDMA as well. Whereas several W-CDMA handset prototypes already exist, CDMA2000 product
development seems to be falling behind. For Qualcomm, this may not mean much, since they get licensing fees from both
standards. But North American companies like Motorola and Lucent may fall behind in W-CDMA development if they
split their early R&D among two, separate standards, both demanding enormous cash infusions.
One big question the Ericsson-Qualcomm deal poses is how it will influence the sales growth of second generation
standards GSM and CDMA. That's hard to gauge - now that W-CDMA is free from litigation worries the development
of this GSM upgrade standard can be accelerated. Qualcomm is stressing that all 3G standards will be "compatible" with
IS-95, the second generation CDMA standard. That may be - but it appears that Ericsson now has the power to
determine the actual meaning of "compatible". And these guys could teach a thing or two about hair-splitting to Bill Gates.
What is certain is that Ericsson will do their damnest to keep W-CDMA much easier to overlay on GSM than CDMA.
Operators now making choices between GSM and IS-95 will have to weigh the implications<TK>.
I appreciate any feedback and try to address issues you raise on the Q&A page.
Tero Kuittinen
Tpkuitti@operoni.helsinki.fi
Tero Kuittinen is a Finnish-based writer with an intense interst in telecom stocks. The opinions expressed are his
own and should not be construed as investment advice. Readers should assume that both Mr. Kuittinen and
associates of DeBry.com have positions in some or all of the securities mentioned, and may change their opinions
and positions at any time.
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