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During the past 20 years, the author has watch China move from being a developing country into an industrial superpower
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|  | DECEMBER 27, 2004
Tech Outlook 2005 –- Part 2 [Page 3 of 3] 3G AT LAST? In the year ahead, we forecast near 700 million handset units will be shipped in the global market. In our view, the normalized growth for handset shipments may be in the 8% to 10% range for 2005 through 2008. Another dimension to the handset market is the transition to 3G CDMA-related networks from 2G global system for mobile communications (GSM) systems. We estimate that 73% of total handsets shipped in 2004 will be GSM-based handsets, vs. 27% for 2G CDMA-related handsets. Our long-term forecast is for 45% of total handsets shipped will be CDMA-based in 2008 compared to 55% for GSM-related handsets. Two companies that we see benefiting from the transition to 3G are Qualcomm (QCOM; strong buy; $43) and Motorola (MOT; strong buy; $18). We view Qualcomm as the best in its class, with one of the most attractive business models in the telecommunications industry. QUALCOMM'S QUALITIES. In many ways, we see parallels to the success Microsoft (MSFT; strong buy; $27) enjoyed in the last decade. Qualcomm has what we see as a unique position of pricing power from its intellectual property in designing CDMA for the mobile wireless industry. The strength of its patents has enabled Qualcomm to receive high-margin license royalty fees from all users, handset and infrastructure suppliers, as well as service providers that use CDMA for software enabling applications. In addition, it's the leading fabless semiconductor company, with more than 98% of the worldwide market for CDMA chipsets. Fabless means the company designs and upgrades its product portfolio of CDMA chipsets, and then outsources the manufacturing to foundries of IBM and Taiwan Semiconductor Manufacturing (TSM; hold; $8). Plus, Qualcomm generates substantial operating cash flow to meet capital requirements, make strategic investments, and pay a dividend on common shares. As of Sept. 30, Qualcomm had approximately $7.6 billion in cash and cash equivalents, or approximately two-thirds of its total assets with no long-term debt. Applying a p-e multiple of 35.3 to our fiscal year 2006 (ending September) EPS estimate of $1.50, a premium to peers that we think is warranted by above-average growth potential, we arrive at our 12-month target price of $53. MOTOROLA'S MARKET. As the number of worldwide users of cell phones has climbed, Motorola has become a leading supplier to the expanding wireless industry. Although it manufactures various electronic products, it's best known for its wireless gear. Motorola's Personal Communications (handsets) segment (45% of 2004 third-quarter sales) primarily manufactures personal two-way radios and wireless handsets in all three major digital standards: GSM, TDMA, and CDMA. The handset segment represents 58% of the company's enterprise value (no other unit accounts for over 13% of enterprise value). Applying an assumed price-to-sales ratio of 1.4 to our 2005 sales per share estimates and using sum-of-the-parts analysis, we arrive at our 12-month target price of $22 for Motorola shares. Ari Bensinger, communications equipment The communications equipment market is experiencing improving fundamentals, in our view, as demand for greater bandwidth to support voice, storage, and streaming-video applications leads to network investment. In both the service-provider and enterprise markets, traditional circuit-switched networks are being replaced with packet-based systems, while wireline networks are being migrated to wireless. Equipment vendors that help customers move to new technologies will likely find significant opportunity as the industry evolves. We see telecom service operators boosting spending on edge network technologies, such as digital service lines and fiber to the premise, to meet impending voice competition from the expected accelerated deployment of voice over Internet protocol by cable operators. However, the new technologies are only a small part of carrier capital spending. Despite continued residential line loss by the regional Bells, we see 2005 telecom spending up slightly. On the enterprise side, we see the Ethernet switching market set for an upgrade cycle to higher gigabit speeds and new Layer 3 routing applications. The core routing market is benefiting from strong consumer broadband growth that's straining the capacity of the data network. We expect industry pricing pressure to intensify from increased competition, especially from Asian manufacturers. Overall, we believe 10% to 15% annual growth in data networking gear is achievable for the next three years. Our favorite stocks include Avaya (AV ), Cisco Systems (CSCO ), and Scientific Atlanta (SFA ), all of which are ranked 4 STARS, or buy. Note: S&P analysts have no stock ownership or financial interest in any of the companies in their coverage area. All of the views expressed accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed. Price charts and required disclosures for all STARS-ranked companies can be found at www.spsecurities.com
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