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STREET WISE by Amey Stone	September 8, 1999

Investing in the wireless phone business is getting trickier. The story used to be that new subscribers around the world were signing up for service in droves and buying the best phones they could find, while current customers were upgrading their handsets as the technology improved.

All that is still true. Growth projections remain phenomenal, as market penetration for mobile phones is still low in much of the developed world -- and as developing countries embrace wireless communications as an easier way than land-based systems to provide phone service to their populations. The global market is growing at an estimated 50% a year, from 163 million phones in 1998, to 240 million in 1999, and a projected 360 million in 2000, says Ed Snyder of investment bank Hambrecht & Quist. "We believe that wireless handsets are now the largest single consumer electronics product in the world," outpacing personal computers, TVs, radios, and hairdryers, says Everen Securities analyst Mark Roberts.

What's changing, though, is that the market for phones -- known as handsets within the industry -- is getting much more competitive. Nokia (NOK), Motorola (MOT), and Ericsson (ERICY) are the big three in the business, but more manufacturers are entering the arena and making millions more phones a year. Germany's Siemens and Japan's Mitsubishi and Matsushita (a division of Panasonic) are expanding into new markets. And increased competition could accelerate price declines, leading to lower profit margins. There's also the threat that newcomers, perhaps from Japan, will come up with the next-generation technology that could unseat the Big Three.

"I don't think we're looking at oversupply next year," says Scott J. Schechter, an analyst with Driehaus Capital Management. "But more production will force some of the traditionally strong manufacturers to lower prices, and they won't be as profitable." While the top three control the majority of the market, "any market share [gained by new entrants] is at the expense of those three," says Schechter. He adds that Nokia, "which has had huge success," could be particularly affected, in part because its margins are still quite high.

LACK OF CONSENSUS. Qualcomm (QCOM), which developed the hottest new digital wireless-phone technology (known as CDMA) is the poster child for such concerns. The stock, which started the year at $26 a share and rocketed to a high of $198 5/8 in late August, has stumbled lately due to the concerns of a few analysts. On Sept. 1, Banc of America Securities analyst Mark A. McKechnie lowered his rating on the stock from strong buy to buy, citing "pinched" handset margins due to increased competition from Nokia and Motorola (which started pushing handsets that use the CDMA standard this year), and higher component prices prompted by shortages. Roberts also warned recently that instead of crushing consensus estimates as it has in recent quarters, Qualcomm may only meet them next quarter. That scared off some of the highflyer's momentum investors, and the stock closed on Sept. 7 at 165 13/16.

For now, there's still no consensus on Wall Street on whether the effects of rising competition, component shortages, and pricing pressures will extend beyond the CDMA arena. Some say the market has overreacted to Qualcomm's handset news, creating a buying opportunity in that stock.

"The prospects for the company could not be rosier," declares Roberts, who adds that handset sales aren't even the most important factor in Qualcomm's business. He sees its primary business as collecting royalties on CDMA sales and turning out the specialized chips that make CDMA work. While a booming CDMA market may mean competition in handsets, it also means more chip sales and royalties for Qualcomm.

Merrill Lynch analyst Michael Ching says that CDMA is bearing the brunt of competition now, because it's the fastest-growing technology. He reiterated his accumulate rating for Qualcomm on Sept. 2, and said that concerns over component shortages were "overdone." Indeed, the industry has overcome past concerns over both competition and component shortages.

PREMATURE WORRIES? Still, Snyder believes that recent concerns over Qualcomm are a sign that investors should stick to the market leaders. In a business with four competing standards (one analog and three digital), as well as four market segments (premium, high-end, middle, and low-end), handset manufacturers need at least 16 phones to cover all the bases. Without the size and breadth to compete in all areas, mid-tier players (he includes Sony, Philips, and Lucent, along with Qualcomm) will get "hammered," he says. Even if such aspirants come out with a top technology, he thinks, Motorola and Nokia will quickly catch up.

Of course, most of Wall Street still believes that the market for handsets will grow so fast that new supplies will be absorbed and that prices won't fall faster than the normal 15% to 20% a year for the industry. Many believe that it is premature to worry about competition, falling prices, and shrinking profits in a market that is growing this fast. "They wouldn't necessarily have to lose market share if the entire market is growing," says Roberts, who favors Qualcomm and Nokia. He also has an outperform rating (a weaker endorsement than a buy rating) on Motorola and Ericsson, reflecting some concerns about their current lofty valuations.

"The opportunity is so big and the growth so great, that when you do hear about competition, that creates buying opportunities," says David Brady, a growth fund portfolio manager at Stein Roe. He looks for companies that he thinks have the best management teams, and on that score likes Qualcomm, Nokia, and Motorola.

Schechter, by contrast, advises investors to look for companies that "have a growing market position rather than a declining one." He thinks leaders Nokia and Motorola could be vulnerable, while Siemens and some Japanese players have potential to gain share in coming years. While his views may not be in the mainstream on Wall Street, investors should bear in mind that an investment in a leading handset manufacturer may not be the sure thing it once was.

Stone is an associate editor at Business Week Online _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

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