Breakthrough Ideas (continued)
Three Premises for Strategic Control
To deduce Qualcomm’s strategic control of valuable spread spectrum architecture required three premises. Specifically, that an investor understood: (1) the ability of spread spectrum’s architecture, when using Qualcomm’s key technology innovations, to provide universal frequency reuse; (2) Qualcomm’s patent rights to its breakthrough intellectual property, which entitled it to compensation for open licensing and protected it from the theft of its proprietary breakthrough ideas; and (3) Qualcomm’s management was competent to continue implementing its standards-based business design in the 3G era. What was the available evidence in 1998 for these three premises that provided the necessary context to pierce the FUD and understand the meaning of Europe’s thinly disguised capitulation in a bitter standards war?
First, Qualcomm had provided an “Introduction to CDMA” at its WEB site, which I downloaded in September 1997 and which appeared subsequently on the CDG site. The key ideas necessary to understand spread spectrum’s architecture were presented on its first page. Described are CDMA as a “radically new concept,” its military origin and uses, and its use of a noise-like carrier wave and wider bandwidths. The required evolutionary developments: the availability of very low cost, high-density digital integrated circuits and the “realization [Breakthrough Idea # 1] that optimal multiple access communication requires that all user stations regulate their transmitter powers to the lowest level that will achieve adequate signal quality.” Next, this Introduction described separating communication channels by using a pseudo-random modulation in the digital domain, not by frequency. Continuing this contrast, the Introduction stated that multiple users occupy the same band of frequency, noting that this universal frequency reuse is not only fortuitous but also crucial to the “very high spectral efficiency that is the hallmark of CDMA.” Finally, the Introduction concluded that CDMA was: Dramatically improving the telephone traffic (Erlang) capacity; Dramatically improving voice quality and eliminating the audible effects of multipath fading; Reducing the incidence of dropped call due to handoff failures; Providing reliable transport mechanisms for data communications, such as facsimile and Internet traffic; Reducing the number of sites needed to support any given amount of traffic; Simplifying site selection; Reducing deployment and operating costs because fewer cell sites are needed; Reducing average transmitted power; Reducing interference to other electronic devices; and Reducing potential health risks.
I conclude that any investor prepared to make the necessary effort to understand and verify these claims could have understood spread spectrum technology and its competitive advantages prior to ETSI’s endorsement of CDMA as its third generation access mode. If you had, then ETSI’s endorsement served as a powerful reinforcement of your investment thesis. Any investor interested by this announcement could have learned, were they willing to invest time and energy, more about the competitive advantages of Qualcomm’s technology that led to it becoming the 3G standard.
As to the second premise about patents, buy-side analyst Gregg Powers, whose firm had the largest institutional position in Qualcomm’s stock, provided enough information about Qualcomm’s patents to educate investors and establish the second premise. Below, I provide selected 1998 quotations from Powers about patents that are drawn from his posts at SI.
February 27 1998. “Patents typically have a seventeen year life, but QC’s IPR has been steadily created over the last six or seven years. So, one could extrapolate a median patent expiration around 2010. However, a royalty bearing license agreement differs from a patent since it is contractual and negotiated. QC’s IS-95 agreements minimally extend through their patent expiration, but (to my surprise) some are perpetual (that boys and girls is not a typo).
The logic for a perpetual obligation derives from the fact that the licensee not only gets to use our IPR (i.e., the tie to the patent life) but gets to accelerate his time-to-market (and therefore his participation in the CDMA opportunity).”
August 11, 1998. “QCOM’s patents are quite broad and cover little details (as I have mentioned) like the basic waveform. . .so ERICY is NOT going to be able to pull a rabbit out of the hat and circumvent the IPR.
Now, let’s address the patent litigation. First, you have to understand the importance of ERICY’s IPR claims relative to IS-95 (answer: peripheral at best) and their likelihood of prevailing (answer: very low according to our [his firm’s] patent counsel (s)). . .let me expand on that for a moment. . .QC has licensed its IPR to over fifty companies (other than ERICY). Each has done their own due diligence on the IPR and NONE, let me repeat that, NONE has required Qualcomm to indemnify them against prospective patent infringement claims. Let me be absolutely crystal clear, when Lucent, Hughes, Phillips, Motorola, Northern Telecom, Nokia, LSI, DSP, Samsung, LG Electronics (and so on and so on) licensed QC’s IPR, they would have conducted their own patent reviews first (so they would not be committed to paying QC royalties while infringing on somebody else’s IPR). If any of these companies believed that ERICY had a blocking or otherwise significant CDMA patent position, they would have required QC to indemnify them for the potential damages. None have done so (and QC has zero contingent liability in this regard). So we have far more than QC’s opinion about its patent position, we have the affirmative economic and legal conclusion of fifty-eight independent licensees.”
September 28 1998. “Please do not speak for me or attempt to characterize my firm’s efforts. I did not get “one” opinion. My firm paid for a detailed patent study conducted by a Washington-based law firm with an international IPR practice. The same type of outside firm, mind you, that your typical international telecom company would use to evaluate the validity and enforceability of intellectual property rights worldwide.
You claim to be expert in patent enforcement yet you seem to misunderstand the nature and breadth of QC IPR related to W-CDMA. The terms “rake receiver” “power control” and “soft handoff” broadly represent a multitude of technological innovations that are protected by several hundred patents in toto. Part of the difficulty in assessing QC’s patent strength derives from the breadth of IPR and the technological abstraction of the underlying concepts. However, since my firm has an investment exceeding $160mm in QC’s equity, we felt that a six-figure IPR review fee was justifiable. Were we given a legal opinion that EVERY patent would stand in all jurisdictions? Of course not. However, we are very comfortable that such a preponderance of the core aspects of ERICY’s W-CDMA involve QC IPR that it will be virtually impossible for QC’s patents to be circumvented . . .
…For the nth time, If ERICY et al could simply circumvent QC’s IPR there would be no debate, no litigation, no fuss and no muss. W-CDMA would be tracking against a firm deployment schedule and this debate would be moot.”
September 30 1998. “There were multiple element to the analysis we requested: (1) identification of the breadth of CDMA-related patents, i.e. in totality, what does the company have, (2) technical relevance of these patents, i.e. which patents appear to be essential to the working IS-95 standard, (3) to what extent does the proposed W-CDMA standard appear to involve IPR directly related to the IS-95 standard, (4) to what extent does the proposed W-CDMA standard appear to involve IPR directly related to other QCOM IPR and (5) to the extent that point three and four overlap with QCOM IPR, how does this line up against ERICY’s U.S. patent portfolio. …
Without publishing the brief, in short, our counsel concluded that while there are some basic differences between IS-95 and W-CDMA, most of the major alternative design elements are in areas peripheral to Qualcomm’s core IPR. While our counsel was loath to speculate on another’s motives, it seems reasonable to conclude that some of the elements of W-CDMA were specifically designed to create bilateral IPR, i.e. the need for Qualcomm to cross license with ERICY in order to build W-CDMA related products. Absent these modifications, W-CDMA is profoundly similar to IS-95.
In summary, W-CDMA appears in many respects to be a tweaked flavor of IS-95 with some very specific incompatibilities and differences. These differences appear to be tactical changes in the standards rather than anything approaching a fundamental alteration of the air interface concept and implementation. Seen from this vantage, and in light of the broad licensing of QCOM”s IPR for IS-95, our counsel’s conclusion seems not only reasonable, but rather obvious.
Beyond the above, the ongoing work relates to a similar review of European patents and a brief on patent protection reciprocity. I hope this is helpful.”
Thank you Mr. Powers. I found it immensely helpful. Therefore, I conclude that any investor could have mined this treasure trove of information and concluded that Qualcomm knew how to manage and had, indeed, protected its IPR.
Third, was their evidence that Qualcomm’s management had the outstanding competence necessary to use these advantages effectively? Assuming that I have established already their technical and strategic competence, here I will limit my evidence to a single long post from Gregg Powers that is similar to other high praise that Qualcomm and the integrity of Irwin Jacobs, specifically, receives from people who know him. But more than praise, this post represents a model of investigation and due diligence that the eminent Phillip Fisher would endorse proudly.
October 16 1998. “Please pardon my frustration with some of the so-called expert opinions that pop up on this Forum. Let me give you a perspective. My firm first became interested in Qualcomm early in 1994 when CDMA was little more than an interesting science project. Cynical disbelievers, my partner and I trekked out to San Diego, met with management, and then began a research process that has continued non-stop since then. In the summer of 1994 we established a modest position in Qualcomm while I continued to fly around the country meeting with the management of virtually every wireless operator in the country (both CDMA proponents and disbelievers). As the controversy heated up and 1994 turned into 1995, various European companies (read Ericsson) began circulating “white papers” delineating precisely why CDMA was inferior to TDMA. Remember now, as a professional money manager, I have access to the management . . . not just investor relations personnel…at virtually all the publicly-traded telecom companies, so I am crystal clear about what was being said, and by whom, during this period.
It really does get my blood pressure up when I reread my notes and see the blatant misinformation (read lies) emanating from Ericsson and various other GSM-centric equipment vendors. Despite the controversy, we trusted our own research and by the end of 1995, my firm had committed in excess of $ 100mm in capital to Qualcomm. Meanwhile, the pressure was rising daily as the background noise increased from the pundits predicting CDMA’s “inevitable failure.” Remember that this was an extremely binary debate, with many well-credentialed experts offering highly-technical opinions as to why Qualcomm’s CDMA would crash and burn. Industry consultants like Herschel Shostek, and so-called academic gurus like Stanford’s Bruce Lusignan, repeatedly predicted plague, pestilence, and “near-far” Armageddon for all those who believed that CDMA would work. I vividly recall engaging Bill Frezza, another so-called industry expert and Ericsson’s former director of marketing and business development, in a rather vociferous debate on the then-active Frezza Forum. Tero and others participated in a cacophony of negativity that at times was mind numbing. So, despite all the apparent risks, and the horrendous implications of being wrong, why did we stay the course?
Through my research efforts, I developed a fairly broad range of industry contacts within the wireless community. We went to pretty extreme lengths. For example, we became Airtouch [now part of Vodaphone] shareholders to gain access to senior technology and network personnel such as Craig Farrill and Gloria Everett…. We met with managers at Ameritech, Sprint, PrimeCo, Southwestern Bell and Bell Atlantic; we also spoke to technical and managerial personnel at Lucent, Motorola, Hughes, Samsung, and Nortel…you get the point. After several thousand hours of research, and the compilation of a multi-year track record, one gets a pretty good feel for who was right and who was wrong, who knew what they were talking about and who was full of bull poo-poo. All of which brings me to Dr. Irwin Jacobs.
I almost cannot comprehend the time, effort, and CPU cycles that I have committed to verifying Irwin’s answers to my questions. Weeks, months, maybe even years of effort…all looking for one deliberate deception, one clever lie or one outright falsehood. Simply put, throughout this period, I cannot point to a single instance where Irwin has deliberately deceived me. Amazing. Yes, development timetables may have slipped and the company’s earnings have not always met my expectations. But these are normal events in the course of any business and certainly do not reflect on management’s candor or integrity. Throughout my almost 15 years in the investment business I have met many smart technical people, many bright businessmen, many shrewd dealers and most everything in between but few men have earned the faith, confidence, and respect that I hold for Irwin Jacobs. You probably won’t believe this, but if I left the investment business, I would rather work for Irwin for free than to work for most anyone else at any compensation level. I find him inspiring, charming, dogmatic, pathologically ethical and absolutely brilliant…if this sounds like idolatry, so be it. But the bottom line remains that Irwin has been absolutely candid and absolutely accurate regarding Qualcomm’s issues, challenges and opportunities. Within this context, he has been absolutely emphatic about the company’s IPR position and his pursuit of convergence.”
Powers continued for another page, but I trust that this is sufficiently convincing that Irwin Jacobs, whom the President of the United States honored with the National Technology Medal in 1994, is a man of proven ability and integrity. Most of us won’t see, assuming that our spirits can see and hear, such heart-felt encomiums at our eulogies.
If the ETSI decision bounded the near-end of the threshold of significance, then the key event that bounded the far-end of the threshold of significance, regardless of its past claims, was Ericsson’s licensing of CDMA. This action spoke louder than words. It confirmed that Qualcomm’s IPR was absolutely necessary for third-generation mobile telecommunications. If you attend to history and if you believe that the forces driving dynamic paths continue to unfold probable futures, then you probably recognized this far earlier than my present breathless disclosure. When Ericsson capitulated, it hedged its bet on W-CDMA by buying the CDMA infrastructure division of Qualcomm. In doing so, Ericsson admitted that it needed lessons in spread spectrum architecture from the master of the art, Qualcomm. It may also mean that China, standing in the wings, had expressed its intention to rely on Qualcomm’s innovative spread spectrum as the 3G technology of choice. Anyone possessing a theory of what is essential to architectural success, the correct facts, and a decent crap-detector could have recognized Qualcomm as a world ruler in the global 3G-landscape. |
