SMARTMONEY.COM: Qualcomm's 2010
Quandary
By TIERNAN RAY
Smartmoney.com
This story was originally published late Thursday.
NEW YORK -- What date was that PaineWebber analyst talking about in
his Qualcomm (QCOM) report? 2010? Why, that's the same year in
which Arthur C. Clarke projects we'll be catching up with HAL the rogue
computer above the gaseous surface of Jupiter. By 2010, you'll probably
be thinking about tapping your IRA, not speculating in tech stocks. Heck,
by 2010, Amazon.com (AMZN) might even be profitable. Truth be told,
2010 is a long, long way off.
But that didn't stop investors from piling into shares of Qualcomm on
Wednesday, driving the stock up 31% or 156 points to a close of $659.
Never mind that QCOM was already up almost 1,800% for the year. All
PaineWebber analyst Walter Piecyk had to do was say that the stock was
hellbent for $1,000 a share over the next 12 months, based on a sure-thing
revenue stream only 10 years out. (Normally, you're lucky if you can get a
Wall Street analyst to focus on the next six months of a company's future,
let alone the next decade.)
Piecyk argued that by 2010, most wireless phones will be a variant of
so-called third generation, or 3G, phones; that those phones will use
code-division multiple access (CDMA) technology almost exclusively; and
that, in Piecyk's words, 'CDMA is Qualcomm.'
Not so fast. Points one and two may be true, but point three is decidedly
less certain. There's no doubt 3G is the next big thing in wireless, as I
wrote back in July. And numerous experts have said PCS phones, many
using some form of CDMA, will take over the wireless market in another
10 years.
But does anyone really think that Qualcomm royalties in 2010 are a sure
thing? It may be true that the company has an unusually strong hold - a
stranglehold, even - on all practical implementations of current CDMA
technology (a method of adding digital codes to a bitstream so that wireless
phone calls can share electromagnetic spectrum more efficiently). But the
CDMA world is changing fast and that could open the door to any number
of competitors down the road.
It's true that Qualcomm's business model is bizarre and rich. The company
maintains CDMA patents going back to 1990. But it's not just an
intellectual property licensee, it is also the main supplier of the fruit of those
patents: chips used in CDMA cell phones. 'You pay us for the chips and a
CDMA royalty,' Qualcomm says to its customers. And that sets up a
strange double-tax for cell-phone makers.
Piecyk figures that if you discount back the $2 billion in chip profits he
expects by 2001, you get $170 a share in value. And if you go through the
same exercise for Piecyk's projected $20 billion in CDMA royalties
through 2010, you get $800 a share in value.
The trouble with this sort of speculation is that there's every indication that
Qualcomm's strange vertical monopoly could come undone over the next
decade - or at least be weakened. Far from cementing the company's
position, as Piecyk contends, the next generation of high-speed wireless
services may actually lessen the company's role in the industry.
Qualcomm's royalties are based on patents. Let's forget for a moment that
those patents - which describe the technology used in today's IS-95
cellular and PCS CDMA standards - will start to expire in 2006 (click
here for the documents at the U.S. Patent Office Web site). Let's simply
recognize that the road to the 3G wireless future is complex.
Indeed, what Piecyk was touting in his Qualcomm report is actually 2.5G,
not 3G, technology. The former is an interim effort that will provide for a
slightly fatter data pipe for cell phones - on the order of 64 kilobits per
second good for sending stock quotes, email and other data to a
Web-enabled phone. True 3G offers up to 2 million bits per second of
data, but it requires more than what Qualcomm is offering at the moment.
To take the next step, wireless companies (including Qualcomm) and
governmental policy organizations from around the world are working on
coordinating the next standard for high-bandwidth mobile gadgets,
including phones. Their efforts are grouped under a general effort called
IMT 2000, organized by the International Telecommunications Union
(ITU), the same folks who ratified the current CDMA standards.
Additional work has been organized by something called the Third
Generation Partnership Program 2, or 3GPP2, which has been set up by
the Telecommunications Industry Association, an American trade body,
and four other international standards bodies with participation from
dozens of companies.
These efforts have led not to the crowning of Qualcomm. Rather, the
efforts are attempting to reconcile a plethora of competing technologies.
They have a gaggle of backers, from Lucent Technologies (LU) to
Japanese electronics maker Oki Electric. Chances are, a direct result of
this process will be a loosening of Qualcomm's current iron grip on the
industry.
Already, there are new patents from other parties, like patent 6,009,074
granted on Tuesday to Korean wireless carrier SK Telecom for its own
CDMA technology. There were also CDMA patents before Qualcomm's,
like patent number 4,293,953, granted to the U.S. military for defense
purposes way back in 1981. There will likely be more in the years to
come.
For its part, Qualcomm maintains that it has enough intellectual property,
with over 1,000 CDMA patents, to lead in delivering technology for IMT
2000's 3G CDMA specifications. Moreover, a company spokesperson
stated that Qualcomm believes the advantages of CDMA technology will
win out over other proposals for IMT 2000, including those based on
GSM and TDMA, two competing technologies.
At the very least, competing intellectual property claims should lead to
cross-licensing agreements that might dilute Qualcomm's royalty stream.
But I think the larger result will be a fueling of competing chipmaking
efforts. Already Korean electronics giant Samsung claims it has produced
CDMA chipsets for shipment in mid-2000 that will support IMT 2000 and
compete with Qualcomm. An excellent write-up in Electronic Buyers
News tells of other challengers.
Then there's a raft of young chipmakers and chip design firms working on
the next generation of radio devices, so-called Software Defined Radio, or
SDR. I wrote about this trend back in August. Conventional chips from
Qualcomm, Texas Instruments (TXN) and others use digital signal
processors with upper processing limits of around 100 million instructions
per second. Companies such as Morphics Technology of Campbell, Calif.,
Vanu of Somerville, Mass., and Sirius Communications of Belgium are all
working on next-generation chip technology that can process more data at
a time in order to handle the high data rates of 3G.
Given that a lot of phone makers are probably chafing at paying
Qualcomm's double tax, it wouldn't be surprising if they closed ranks
around some of these competing products if only to free themselves from a
monopoly. Think about it: How many microprocessor orders get thrown
the way of Advanced Micro Devices (AMD) because the big PC makers
want an alternative to Intel (INTC)?
In short, there could be something of an industry backlash down the road
and that's scary for a company that has yet to face any real competition.
Qualcomm guards its monopoly in secrecy, and that has built ill will.
Numerous complaints have arisen in the past about obstacles Qualcomm
has thrown in the path of fellow chipmakers such as Motorola (MOT)
who've tried to build chipsets based on Qualcomm's intellectual property.
When I began to look into 3G wireless earlier this year, the one chipmaker
that would not sit down and talk with me about its plans for 3G was
Qualcomm. Motorola, Texas Instruments everyone came to the table but
QCOM. And this is the company that's banking on 3G?
Don't get me wrong. I have no beef with Qualcomm's upcoming
technology. It may be very good, for all I know. And I'm quite willing to
believe the company will be churning out CDMA chips in 2010. Nor do I
underestimate the courage of Irwin Jacobs and the other founders of
Qualcomm, who put everything behind CDMA when a lot of people in the
wireless industry said the technology wouldn't work at all. Nor do I take
issue with overly exuberant Wall Street analysts who set ridiculous price
targets. Certainly a doubling of Qualcomm stock in the next 12 months is
not unreasonable. It's after that I'm worried about.
All I am saying is that investors who looked at a stock valuation based on
2010 results and didn't blink - and who are counting on a fantasy $800 per
share in royalties to support their long-term analysis - well, those people
might want to surf on over to the Web page of the U.S. Patent Office and
keep a watch. Already, the intellectual property waters are rising around
Qualcomm
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