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Collecting Tolls at Qualcomm...
07/15/2005 12:00 am EST
"Screening" is an analytical approach to
isolate issues that meet certain predetermined criteria. Few have pioneered this
area as comprehensively as Marc Gerstein, columnist for Reuters.com
and editor of The
Reuters Value Report. Here, his screening leads to a call
"Qualcomm (QCOM NASDAQ) is one of those hot-button companies that inspires vigorous reactions. There definitely are many fans of this wireless intellectual-property powerhouse. But the company also seems to attract considerable disdain; probably having something to do with the license fees and ongoing royalties it collects on the many cell phones that use its technology protocols. Nobody loves the toll collector, and everybody thinks the toll is too high. Another factor may be lingering emotional baggage from the bubble, when QCOM was one of those stocks with absurd high-profile price targets. But the stock has often appeared in our screens and was recently in the screen for Strong Operating Margins, so there must be something worth discussing here besides emotion.
"Besides intellectual property, QCOM also manufactures chips for use in cell phones based on its protocols. Frankly, though, this is not a big source of investment appeal. Competition is brutal. One rival, Nokia, is a very low-cost operation that makes pricing treacherous, and Texas Instruments is getting into the fray. Ultimately, an investment case for or against QCOM should be tied to the intellectual property, which stems from the company's status as the inventor of CDMA, one of the main wireless communication protocols in use today, and the one that is most heavily used in the US. The rival protocol, GSM, is big elsewhere in the world. But change is coming.
"3G is a common acronym for the third generation of wireless communications. This technology will be distinguished from predecessors by its ability to transmit not just voice, but also data, images, video, and audio. It may look like we're already seeing this. What's happening, though, is that 3G content is essentially being squeezed through a 2G pipe. It works. But it's not especially good. The bigger takeaway from current efforts to transmit things other than voice through 2G pipes is how strong demand really is. Imagine what it will be like when the industry is on 3G and able to effectively serve not just cellular geeks, but the average person as well.
"The two 3G standards both derive from QCOM's basic CDMA technology. That means QCOM will get license fees and royalties from a much larger phone base than is the case at present. T he QCOM 'toll booth' is a huge source of resentment. So you can be sure that many will do anything they legally can to get away from it. That spells lots of litigation as parties try to find ways of limiting the scope and extent of QCOM's intellectual property. So far, the company has defended its interests well. But legal attacks are likely to keep coming. Meanwhile, another, perhaps bigger, source of risk comes from wi-fi transmission. QCOM has a platform for this (BREW). But Intel is big here, and it's way too early to say whether or not there is potential for convergence between wi-fi and 3G and, if so, what role will be played by what companies.
"Helped by the absurd price target published back in the bubble days, many investors have suffered losses, realized and unrealized, in this stock. As a consequence, many have strong negative feelings about it. Nevertheless, it is incumbent on us to try to cut through that emotion and develop rational assumptions. Doing that, I estimate that QCOM's stock price would be reasonable if earnings per share over the next five years could grow at an annual rate of 14.8% or better. To get there, I assume a trailing 12-month relative (company-to-S&P 500) P/E of 1.31, which is actually a bit lower than the present 1.59 level.
"Of the 34 analysts who cover the stock, only 18 bother to project a long-term EPS growth rate. Among those that make efforts, the range is 15% to 35%, with a consensus of 19.98%. A wide range with a relatively small number of analysts who try to forecast would normally bother me. But here, I can live with it because my required growth rate would be achieved even at the bottom of the range. And there is reason to think QCOM might surpass the low figure given the new product cycle that lies ahead. Overall, the next generation of wireless is likely to mean more passages through the Qualcomm toll booth."
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