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Why Qualcomm isnt the next Kodak
A new technology, WiMax, threatens Qualcomm's technical edge, just as digital photography did with Kodak. But at the moment, Qualcomm is at the forefront of several key developments.
By Robert Walberg
One of the problems with investing in tech companies is that technology is constantly changing. Those companies that adapt quickly to change tend to flourish; those that don't are soon forgotten.
Eastman Kodak (EK, news, msgs) is an example of a company that moved too slowly in transitioning to digital, and the company and its shareholders have been paying the price ever since. To some investors, Qualcomm (QCOM, news, msgs) faces a similar challenge as its leadership in code-division multiple access, or CDMA, technology for cell phones is being threatened.
The threat doesn't come from heightened competition so much as it does from the potential for a new technology that would alter the demand for CDMA, thereby reducing Qualcomm's license and royalty revenues. That technology is called WiMax, which is short for worldwide interoperability for microwave access.
Basically, WiMax is a pumped-up version of WiFi, in that users will be able to access the Internet with a wireless card from within a range of 30 miles rather than 300 feet, at speeds far greater than with even a cable modem. The technology could also be used by telecom companies such as AT&T (T, news, msgs) to bypass the fees paid to local carriers for last-mile access to customers.
There are still major hurdles to broad adoption of WiMax, such as costs and compatibility. However, Intel (INTC, news, msgs) is spearheading the transition to WiMax, and its new Rosedale chip is priced at a point that is expected to accelerate adoption. Intel is also partnering with Sprint (FON, news, msgs) in the development and deployment of WiMax standards. For Intel, the widespread adoption of WiMax would bolster its leadership in notebook-computer chip sales. Sprint sees the technology enhancing its role in providing wireless interactive multimedia services.
A real threat?
Though WiMax is probably years away from being a serious threat to Qualcomm, should telecom-service providers invest the capital equipment needed to build out a WiMax-based mobile wireless network, the threat to Qualcomm's core business could prove very real. But WiMax technology alone isn't reason enough for investors to shy away from Qualcomm's stock, at least not yet.
Qualcomm remains the leader in CDMA technology, and it stands to benefit from Europe's transition to next-generation WCDMA technology. The transition to so-called third-generation wireless services has been a bit slower than originally anticipated, prompting Qualcomm to lower its revenue guidance for fiscal 2005 several weeks ago. But improved pricing, reduced inventory and enhanced product offerings should help propel sales in the year's second half.
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The company also recently entered into WCDMA license agreements with four Chinese equipment manufacturers, which should increase CDMA penetration in China, the world's largest wireless market.
Qualcomm also is working hard and spending considerable sums to develop its MediaFlo subsidiary. This unit is building a network to broadcast TV to phones, and Qualcomm has indicated that a number of entertainment companies and content providers are interested in using MediaFlo as a media distribution mechanism. As I wrote in a recent article on Electronic Arts (ERTS, news, msgs), the mobile entertainment market is exploding. With MediaFlo, Qualcomm is positioning itself to take advantage of the boom.
Making headway
In addition, Qualcomm is making significant headway in other markets, as it shifts from being a CDMA-centered business to an acknowledged leader in an array of mobile multimedia communication technologies. In fact, the company's QCT unit is developing solutions that contain embedded support for global positioning systems, video, camera, Bluetooth and MP3s. The company's early lead in the fast-growing mobile resource management markets, with its OmniTRACS, OmniOne, GlobalTRACS and TrailerTRACS units, should also help drive long-term sales and earnings growth.
So while WiMax is a distant threat to its core business, Qualcomm's management deserves credit for aggressively expanding its business to reduce dependency on CDMA technologies. That's not to reduce the significance of CDMA/WCDMA to the company's top and bottom lines, but it does suggest that management won't be caught off guard by the changing technology landscape. To the contrary, Qualcomm appears to be at the forefront of several emerging markets that could well drive double-digit sales and earnings growth for many years to come.
Nevertheless, until investors see a rebound in the growth of WDCMA adoption, especially in Europe, the stock is apt to struggle. The Street sees Qualcomm earning $1.13 in fiscal 2005, which ends in September, a scant 2.7% increase over year-ago earnings. Such limited growth doesn't support a price-to-earnings ratio of almost 33 times based on projected earnings and a trailing 12-month price-to-sales ratio of 11.7.
A big rebound
Now if the Street is correct, sales and earnings will rebound significantly in fiscal 2006, as lower handset prices and more attractive styling options drive demand. Current forecasts are for earnings of $1.42 a share on sales of $6.88 billion, representing year-over-year gains of 26% and 22%, respectively. To warrant its current multiples, Qualcomm must deliver top- and bottom-line growth approximating 20%. Failure to do so will almost certainly lead to serious contraction of those multiples -- and likely a lower stock price.  |
Qualcomm is an industry leader in the midst of a product transition that's hampering sales and earnings growth. But its strong balance sheet -- almost $4 per share in cash with no debt -- high return on equity and experienced management team suggest that any transition will prove short-lived and that the company will get back on track in short order.
It's possible that WiMax will change the landscape in the wireless world and turn Qualcomm into a second-tier player, but it's unlikely. For one, the cost to adopt WiMax on a widespread basis is prohibitive. But more importantly to Qualcomm shareholders is the knowledge that its management team is doing everything in its power to position the company to take advantage of today's technology lead.
At the same time, Qualcomm is developing technologies that'll enable the company to maintain its leadership position for many years to come. So long-term investors will want to take advantage of any near-term weakness to buy around $33 to $34 a share, with a long-term target of $46.50.
At the time of publication, Robert Walberg neither owned nor controlled shares in any equities mentioned in this column.
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