From Barron's weekday trader
By Carolyn Whelan
The sun seemed like it would never set on Qualcomm.
The San Diego, CA-based company, which sells wireless chips, handsets and
licenses based on its cutting-edge data communications technology, CDMA
(Code Division Multiple Access), has seen its stock go up fivefold since we
wrote a positive story about it on February 9 (see Weekday Trader, "Bulls
Say Qualcomm Is Poised For More Gains"). In fact, it closed out August as
the top-performing stock in the S&P 500 index thus far in 1999, peaking near
200.
But last week Qualcomm broke its winning streak. Mark
Roberts, an analyst at Everen Securities, first let some air
out of the Qualcomm balloon on September 1, when he
warned that Qualcomm's earnings growth wouldn't surprise
as much on the up side as it has in the recent past. (Roberts still thinks it will
meet quarterly consensus earnings estimates of 88 cents and beat by six cents
a share the $2.39 it is expected to earn in the fiscal year ending in September.)
A downgrade by Banc of America Securities, to Buy from Strong Buy,
deflated the shares even more. Reports of some widespread insider selling
raised eyebrows, too.
The final straw: News of price erosion
in the digital handset business.
Qualcomm has been the only supplier of
CDMA handsets, giving it real pricing
power. But investors worry that
aggressive pricing by new entrants
Motorola and Nokia might impact
Qualcomm's bottom line.
The bottom line for the stock: In just
one day, it lost 23 points, or 12% of its
value.
It was a "shoot first, ask questions later" situation, explains Pete Peterson, a
senior wireless communications analyst at Volpe, Brown & Whelan. "The
market was jittery because [Qualcomm] was at such high levels."
Or, as Wojtek Uzdelewizcz, a research analyst at SG Cowen, puts it:
"Momentum investors dumped the stock."
But though some seemed ready to take profits after such a huge run, others
see the exodus as a good buying opportunity for a technology leader.
"[It's] more attractive and much more digestible, particularly when the growth
drivers are still intact," adds Peterson.
Most of the people with whom Barron's Online spoke agree that the
company's fundamentals are intact. "The outlook for CDMA is as good as
ever," says Uzdelewizcz.
It certainly appears to be. Unit sales of CDMA handsets are expected to
grow nearly sixfold to 40.3 million in 2003, up from 6.8 million in 1998,
according to the International Data Corp. CDMA is the standard in Korea,
Canada, the United States, Brazil, Australia and New Zealand, and is making
significant inroads into growing, populated countries like Mexico and China.
Today Qualcomm makes 45% of its revenues -- but less than 10% of profits
-- from handsets. Another 30% of sales comes from chipsets for CDMA
handsets, while 10% of sales are generated by licensing fees and royalties
from key CDMA patents the company holds.
Together, chipsets and royalties generate more than 75% of the company's
profits, according to Peterson. Today, more than 60 CDMA gear
manufacturers pay royalties to Qualcomm, including market leader Sprint.
"The earnings power to Qualcomm has nothing to do with handsets, which is
on the margin," says Roberts. "The biggest benefit [of handset sales] is
royalties," adds Uzdelewizcz.
That's why, paradoxically, competition could actually help Qualcomm. Since
royalties grow with each CDMA phone sold -- regardless of the manufacturer
-- aggressive participation by big names like Nokia and Motorola, which have
serious marketing and production muscle, can help drive that growth faster.
"Qualcomm's real goal is to grow the pie that is the CDMA market," explains
Peterson.
Insider trading fears, too, might be overblown. "Certainly the selling occurred,"
explains Bob Gabele, director of insider research at First Call. Last month,
president and CEO Richard Sulpizio filed his intention to sell 50,000 shares,
and director Neil Kadisha said he would sell 750,000 shares, according to
144 filings. Other top officers unloaded more than 500,000 shares in July.
But Gabele calls that nothing "out of the ordinary, given the significant move in
the stock and the company's trading history."
Finally, there are widespread rumors that Qualcomm might eventually exit the
handset market entirely. Qualcomm entered that segment to brand its own
business and drive adoption of CDMA, which is already well under way.
"The strategic imperative for them to be in [the handset] business will go down
as new entrants come in," explains Peterson.
Qualcomm has been noncommittal about the future of that unit. But it has said
that it is in the business to make money. So, a departure -- not unlike the sale
of its unprofitable infrastructure business to L.M. Ericsson in May -- would
not be a surprise, and could even give the shares a shot in the arm.
At Wednesday's closing price of 167 7/8, Qualcomm stock is 13% off its high
of 192 3/16 that it set in August -- though it changes hands at a high 70 times
expected earnings of $2.39 a share for the fiscal year ending in September,
according to First Call. That's double its projected long-term annual earnings
growth rate of 35%. But its P/E of 45x estimated fiscal 2000 earnings of
$3.70 a share is at a healthy discount to both its estimated 2000 earnings
growth rate of 55% and to its five-year average P/E of 75x.
There are, of course, risks. Qualcomm could lose share in the CDMA chip
market, or suffer in any international crisis that slows sales of communications
gear. Another key challenge is narrowing the abyss between its most and least
profitable ventures, says Peterson. Divesting the handset business would help
solve that.
And there remain some adoption issues as buyers go for competing
technologies like GSM. But that risk is dissipating quickly. "There's significant
acceptance [of CDMA] in the market place," says Peterson.
And, it seems, for Qualcomm stock as well -- even after its huge run and last
week's drop. |
