SmartMoney. Is Qualcomm the Microsoft of Wireless?
[Apologies if already posted. Go QCOM/GSTRF...]
April 9, 1999
By Alec Appelbaum
SUCCESS for a technology company is all about creating -- and profiting from -- a standard,
even a de facto standard. For proof, look no further than Microsoft Windows, Cisco Systems
and Intel's Pentium microprocessors. Now, investors are bidding up shares of
wireless-communications company Qualcomm (QCOM) as though it is about to join that
exclusive club.
It certainly seems possible. Last month, Qualcomm resolved a long-standing patent lawsuit
with rival manufacturer Ericsson (ERICY) that essentially gives Qualcomm the right to collect
a 2% to 5% royalty on the wholesale price of every wireless handset made using its
technological standard, known as CDMA. As part of the agreement, Qualcomm also sold its
costly wireless-network infrastructure business to Ericsson. Then came the piece de
resistance. China announced that it would allow the buildout of a wireless network using
CDMA. Is it any wonder Qualcomm shares are up 86% in the past four weeks?
But even with the prospect of a few hundred million Chinese talking away on CDMA-equipped
phones (which is far from a sure thing), that standard is no Microsoft Windows. There are two
other competing standards -- GSM and TDMA -- that are widespread in Europe and the U.S.,
respectively. And the parallel between Microsoft and Qualcomm breaks down in other
respects as well. In addition to controlling the CDMA standard, Qualcomm also makes CDMA
phones -- and in that area it has some pretty stiff competition.
There are other uncertainties. The price Ericsson is paying Qualcomm remains a mystery, and future savings aren't much clearer since
the company doesn't separate phones from bay stations (its infrastructure business) in expense reports. Everyone agrees the station
business suffered losses, but it also produced roughly $500 million a year in sales, estimates Volpe Brown Whelan's Pete Peterson.
Without knowing how firmly the cost savings will balance the lost revenues, it's hard to gauge how the deal will stoke short-term growth.
Raj Srikanth of First Albany expects year-2000 revenues, devoid of infrastructure, to be basically flat with 1999 sales.
Does $500 million matter to a company with $3.3 billion in 1998 revenues? It does when Motorola (MOT) and Nokia (NOK/A) are
peddling new CDMA-compatible phones. "Nokia and Motorola are going to fight very hard, especially around Christmas time," says
Srikanth. The approach of these big dogs has NationsBanc Montgomery Securities' Mark McKechnie clinging to his Hold rating, even
though he says the Ericsson resolution makes Qualcomm's story "tremendously better" than it was a month ago. Nokia sells phones to
AT&T (T) for that company's market-leading Digital OneRate service; Motorola supplies Nextel (NXTL) and analysts say it's targeted
Sprint PCS (PCS) -- a CDMA devotee and Qualcomm customer -- for new units.
From where McKechnie sits, if Motorola and Nokia take away some of Qualcomm's phone business, the new royalty revenue Qualcomm
will receive won't necessarily compensate. Peterson disagrees. He thinks that a small bite of every phone sale will make Qualcomm just
as rich as Motorola and Nokia can get through increasing their own sales. But much depends on how the wireless market grows.
According to the Cellular Telecommunications Industry Association, annual U.S. wireless-service revenues increased 20.4% in 1998,
while capital investment grew 31%. More consumers say they care about price than sound quality; if CDMA is a more cost-efficient
technology, its spread could help service providers stoke demand with more price reductions.
But Qualcomm's runup doesn't draw solely on the vision of more rude people at the local multiplex using mobile phones. The day the
Chinese government announced its willingness to allow CDMA networks, Qualcomm rose another 6.3%. Never mind those barriers firmly
beyond the company's control -- political static between the U.S. and China over trade (and between the president and the Congress
over U.S. posture to China), squabbles between Chinese military and civil officials, the world economy, to name a few. Qualcomm also
bears all currency risk when it sells phone overseas; if China devalues its currency, Qualcomm's revenues would fall. Nonetheless, the
idea of a market where 10% penetration equals 120 million new customers tantalizes some speculators. "Somewhere along the road,
[Chinese people] are going to be able to afford cell phones," argues Srikanth. If the government resumes four stalled CDMA tests and
selects the technology for its densely populated cities, he says, Qualcomm could ring up hundreds of millions in new orders. Still, that's
quite an "if." "You cannot buy based on China alone," says Srikanth.
At these prices, you'd better buy based on something firm. Peterson argues that a premium must apply to Qualcomm's "lock on
technology that's going to be deployed around the world." Perhaps. But traders in the tech sector can be fickle. After Motorola and
Nokia make their pitches, and China's posture toward U.S. imports emerges from negotiations, Qualcomm's stock price may be more
irrefutable. For now, there's some static on the line.
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