Qualcomm: Patented formula for success

Qualcomm girds for a strong challenge as the cellular market moves toward technologies it doesn't own.

By Erik Sherman -- Movers & Shakers, 11/1/2004

Qualcomm may not have a license to print money, but it has had a license to collect it by phone. The company invented CDMA (code division multiple access) technology and has been the financial beneficiary of it for years. Today cellular networks are moving toward technologies where Qualcomm has less of a lock. But the company is innovative and has billions in cash on hand to fund its strategies.

Paul Jacobs, Group President, Wireless and Internet, Qualcomm

In 2003, Qualcomm's revenue came in just shy of $4 billion, with an operating margin of 37.1 percent—a good deal higher than 22.5 percent the year before. Even net profit margins scored in the double digits, at 20.8 percent. The company's cash position jumped 45 percent from 2002, giving it more than $2 billion on hand.

Fiscal-year 2004, which ended in September, is looking equally impressive. Revenue for the first three quarters reached almost $3.8 billion, with operating margins of nearly 45 percent and a net profit margin of 36.3 percent.

And according to Qualcomm management, the company is positioned for more success. Subscriber numbers in the wireless industry should grow from about 1.5 billion in 2004 to almost 2.5 billion in the 2008 time frame, president and COO Tony Thornley told the annual Bear Stearns Technology Conference in June. Much of that growth will come in the data-friendly 3G CDMA technology market.

"They created the standard, so they reap all the benefits from everyone using it," says iSuppli analyst Scott Smyser. For a long time, the company was the sole supplier of CDMA chips and also received royalties on the use of the technology. But a cross-licensing agreement is giving Texas Instruments and STMicroelectronics the right to also go after this market. Qualcomm sued TI, asking the court to invalidate the cross-licensing agreement, but failed, Smyser adds. And TI and STMicro both announced this year that they would not pay licenses to Qualcomm.

That poses a problem. While it's all well and good to talk about the 3G ramp, Qualcomm cannot afford to ignore its bread and butter. The company has a number of product lines, including various cell technologies, application-development software for handsets, various wireless communications and tracking systems, and even a digital movie and video delivery system in the works. But in 2003, 61 percent of revenue came from the CDMA Technologies division.

That tight focus has been a blessing to earnings, but the natural drawback is that any attack on the CDMA revenue stream becomes a significant concern.

And the two contenders are not to be taken lightly. Both TI and ST are major semiconductor players—bigger than Qualcomm—and already active in the handset market. The fact that Qualcomm looked for a court remedy indicates that it takes the threat seriously.

Another weakness of the current reliance on CDMA is that adoption of the technology is concentrated in relatively few countries. Look at the geographic distribution of Qualcomm's 2003 sales, according to financial site Hoovers.com: 22 percent in the US, 43 percent in Korea, and 15 percent in Japan. These are obviously lucrative markets, but the fact remains that 80 percent of the corporate eggs are in a small basket.

What Qualcomm needs is an infusion and diversification of new sales opportunities. And that's what the company has been working on. The cellular industry's biggest opportunity is 3G systems with the capacity for high-speed data traffic. Qualcomm has been busy pursuing the opportunity with two technologies: CDMA2000 1xEV-DO, built on CDMA, and WCDMA (wideband CDMA), which is an outgrowth of today's widespread GSM technology.

The change has already allowed Qualcomm garner more sales in GSM-centric Europe, says Paul Jacobs, group president of the company's wireless and Internet group. "All the big operators are going to WCDMA now," he says. "We already have 21 device manufacturers using our WCDMA chipsets," he says. "We have a company target to try to get 50 percent of the GSM chipsets."

However, Qualcomm doesn't have the natural advantage in WCDMA that it had in CDMA. NEC has a larger share of the WCDMA market, according to Smyser. And although Qualcomm still has a significant number of patents—20 percent of the total WCDMA patents that exist, according to some sources—the flow of assured money will be smaller.

Furthermore, the waking giant of China is causing its own problems. While Qualcomm gets 8 percent of its sales from China, companies there have developed a government-blessed alternative 3G technology called TD-SCDMA (time division synchronous CDMA). And those companies have been refusing to pay royalties, claiming that the technology does not use any Qualcomm patents.

"The issue, then, is can they avoid all claims on all patents?" Thornley asked in June. "Its hard to imagine." However, Qualcomm must be aware of how the Chinese government invalidated Pfizer's patent on the drug Viagra when Chinese companies wanted to directly compete in Asia. And those businesses couldn't even make the argument that they had developed a variation of the product on their own.

But Qualcomm sees another opportunity: working with the cellular providers to identify new services for users, then designing chips to meet those needs before competitors can react. People in Japan and Korea regularly spend upwards of $400 for a handset. And even then they sometimes change units twice a year. "We're in the lead, and we're able to spend an awful lot of money on R&D because we're in that leadership position," Jacobs says. "It's actually fundamental to our strategy. We're in the leading position, so we innovate and integrate and we can get a premium price so long as our competitors don't have [those features]."

Qualcomm is pushing to keep offering chips with the highest performance and the lowest power consumption. That increasing silicon power would let the company's chips support virtually every standard, expanding potential markets.

Qualcomm bets that multimedia will be one of the big drivers, and it won't be long until handsets have VGA-resolution displays and multigigabyte hard-disk drives.

The company is a champ at integrating multiple capabilities onto chips, Smyser says, and it is also coming out with RF solutions that use CMOS technology, which will make them cheaper than what is already on the market. If the company can keep fueling the technical march, then there is a good chance that its financial success will continue.