etrade.com
Daily Stock Brief by Briefing.com
Updated: 13-Jan-00
InterDigital Communications
[BRIEFING.COM - Robert V. Green] Whenever we kick the tires on a
concept investment, we get a flood of emails from true believers who
don't like it. This happened recently with InterDigital Communications
(IDC), a stock which rose from $5 to $80 on the concept that it is a
"baby Qualcomm." Since everyone and their grandmother wishes they
had bought Qualcomm a year ago, the very phrase is enough to get
some investors to take action. But IDC isn't a baby Qualcomm.
The Baby Qualcomm Concept
Qualcomm (QCOM) firmly established their CDMA format, as a
royalty bearing vehicle, before selling off their infrastructure business
and, now, their handset business.
When people say that IDC is a "baby Qualcomm" they primarily mean
that IDC will also be a royalty model, with revenues on the scale of
Qualcomm ($4 billion). The royalty model is valuable because it is
leveraged. Operating margin increases as revenues increase.
These are the key reasons Qualcomm rose from $25 to $600 in one
year:
CDMA made giant steps against the dominance of GSM phones
(the acceptance by China of CDMA helped this a lot. Previously
China was an all GSM wireless infrastructure, and there was
essentially no CDMA infrastructure at all. )
Qualcomm settled patent suits with Ericsson. (The acceptance
by China Unicom of CDMA, and their announcement of plans to
build a CDMA infrastructure with 40 million user capacity, came
one day after the settlement with Ericsson was announced. We
don't think the settlement was a coincidence. Ericsson was/is
the dominant vendor in China, but any move to CDMA would
hurt them. )
Qualcomm moved much closer to a leveraged business model.
The market values this leverage much more highly than
manufacturing models.
Qualcomm began investing in the next generation of wireless
broadband (HDR).
Momentum players poured into the stock.
Qualcomm established a proven royalty stream based on CDMA
before moving to the more leveraged business model they have now
embraced.
The moniker "baby Qualcomm" began being applied to IDC because
IDC is essentially an intellectual property engineering firm. In the same
way that Aware (AWRE) and fabless semiconductor companies
develop technology, then license the manufacturing to others, IDC's
business model involves development and licensing of new
technology. They do not manufacture or distribute physical product on
their own.
The problem with IDC, which is where our "tire-kicking" comes in, is
that the expected royalty stream coming to IDC is unproven. The
current royalty stream is based on existing TDMA and CDMA license
agreements, but a quick glance at IDC's quarterly revenue stream
shows that that stream is dying, not growing.
Five Wrong Premises Behind the "Baby
Qualcomm" Idea
Here are some of the premises that were emailed to us, in argument
that IDC truly was deserving of the title "baby Qualcomm."
Briefing.com called both IDC and Qualcomm to test these premises.
Here is what we found.
Premise 1: Qualcomm pays IDC royalties because IDC owns
CDMA patents. IDC does own CDMA patents. But Qualcomm and
IDC settled any ownership dispute over these patents in 1994 with a
single one-time payment to IDC from Qualcomm and a perpetual
license agreement.
IDC receives no current royalties from Qualcomm on an ongoing
basis. Numerous emailers to us claimed that they do. Where this idea
comes from, we have no idea. Even a brief look at IDC's revenue
stream should convince anyone that they aren't participating in the
boom that Qualcomm enjoyed. Nevertheless, we asked both
companies and both IDC and Qualcomm verified that no current
royalty relationship exists between the two companies.
Premise 2: Qualcomm will pay IDC royalties in the future for 3G
CDMA phones, because the 1994 lawsuit does not cover
technology needed for 3G phones.
IDC does own patents on B-CDMA technology, which is not covered
by the 1994 settlement.
But this is irrelevant to Qualcomm's future. Qualcomm stated
unequivocally to Briefing.com that they "don't see any need for
Qualcomm to use any existing IDC patents in the future" and that they
"do not expect to pay IDC royalties" going forward. It can't be any
clearer.
Premise 3: Everyone building a 3G phone will pay IDC a royalty
in the future. This premise is based on the idea that IDC owns
essential patents for the 3G standard.
IDC is developing technology for the 3G standard, but so are many
others. IDC has not identified to ITU any specific patents that would
require royalty payments, to anyone, not just Qualcomm. (Source:
Both IDC and Qualcomm.). Such an assertion would be standard
procedure for any vendor submitting technology to an international
standards board. Any presumption that IDC will own royalty-bearing
intellectual property for 3G technology that is sanctioned by ITU is
currently just a presumption.
Premise 4: Every current GSM and TDMA phone vendor owes
IDC money for past infringement and it amounts to billions. This
idea falls into the "maybe" category. It stems from the idea that the
current Ericsson/IDC cross lawsuits are going to result in a judgement
for IDC, and that back royalties will be awarded. The idea is exciting
because of the vast amount of phones sold which are claimed under
the lawsuit.
But prejudging the outcome of any lawsuit, with your investment
dollars, is a very risky proposition. Furthermore, the trial schedule is
not expected to conclude, according to IDC, until the end of 2000 or
early 2001. The April date that numerous emailers pointed to is only a
hearing, with a single judge, and will not result in final disposition of the
case. An investment on this premise requires at least a year's time
frame.
Furthermore, even if IDC wins, there is no assurance that the royalty
payments would amount to "billions." But even a judgement in the
hundreds of millions wouldn't justify the current market cap of IDC, in
our view, if it were a one-time payment.
Many people emailed us saying that a judgement for IDC was a given,
since the Patent Office recently reaffirmed existing IDC patents. But a
reaffirmation by the Patent Office is a nonevent, in patent litigation.
When patents are overturned, it happens in court, not by the Patent
Office. A reaffirmation is obviously a positive sign, but it does not
mean that the IDC patents cannot be declared invalid.
Premise 5: IDC is currently receiving royalty payments from
Nokia, and will in the future. Numerous people stated that Nokia is
already paying IDC in the neighborhood of $40 million in royalty
payments for IDC intellectual property, and therefore IDC will receive
something for every 3G Nokia phone going forward.
Nokia has contracted with IDC for technology development that might
be part of Nokia's 3G technology. The bulk of the Nokia payments so
far represent development costs, although the payments also include
a prepayment of licensing rights to a limited extent. This was verified
by Briefing.com directly with IDC, although IDC would not comment on
any possible royalty relationship into the future, or the terms, if any, of
future royalty payments Nokia might make.
While it is obviously positive that Nokia has employed IDC, investors
should realize that Nokia has its own development group working on
the same essential technology that IDC is working on. IDC
acknowledged that the work being done for Nokia was not Nokia's sole
3G technology effort. (We were unable to confirm with Nokia.)
Possibilities For IDC
While we think the "baby Qualcomm" concept is an erroneous way to
look at IDC, it doesn't mean that IDC isn't a possible speculative play.
Here are three real possibilities to justify an investment in IDC, but
everyone of them currently has no proven revenue stream.
Chip sales: IDC is currently working with Texas Instruments to
develop B-CDMA chips. IDC is also looking for additional
relationships with semiconductor manufacturer to build IDC
designed chips. This "fabless" semiconductor relationship is an
established model in the semiconductor industry. But it requires
demand for IDC designs. Unfortunately, there is not, to date, an
established stream of revenue from sale of these chips upon
which to formulate an estimate of market demand.
Nokia relationship: The Nokia relationship has possibilities. But
since a future royalty stream can't be confirmed, even directly
from IDC, it is hard to quantify what this means. But IDC will
own the intellectual rights to any technology they develop for
Nokia, meaning they can license whatever they develop to
anyone else. That is a good position to be in, but it doesn't mean
that anyone wants, yet, what IDC owns.
The Ericsson suit: It is always possible that IDC will receive a
large settlement for past patent infringement. But without
knowing what IDC would do with the money, it is a lottery ticket
with an unknown payoff. All it really means is IDC would have no
capital problems. But that doesn't guarantee future earnings.
Actually, for us at Briefing.com, all of these would be interesting
propositions, at the right price. Unfortunately, IDC is way beyond that
price (IDC closed yesterday at $30 1/8.)
We aren't alone in being uncomfortable about an inability to quantify
IDC's future business plans. The sole analyst covering IDC, Ram
Kasargod, of Morgan Keegan, dropped coverage on 1/11/00 because
no details of possible revenue streams were available, upon which to
base a valuation.
Final Analysis
None of this discussion means that IDC will fail, or that IDC stock will
drop, or rise.
But we believe that any investment needs to be analyzed on a
risk/reward basis. With IDC, it is rather easy to calculate the risks, but
nearly impossible to calculate the rewards. Qualcomm, on the other
hand, is not a speculative investment in any way, although you might
argue about the valuation.
Nevertheless, speculation is appropriate for some investors, as long
as you recognize what it is. Somehow, we have a feeling that most
who bought on the "baby Qualcomm" concept never really understood
IDC.
Comments can be emailed to the author, Robert V. Green, at
rvgreen@briefing.com. |
