Why Qualcomm Keeps Ringing


By Arlene Weintraub As they like to say in sports, 2004 was supposed to be a "rebuilding" year for Qualcomm (QCOM). Analysts expected that sales of wireless phones powered by Qualcomm's patented CDMA technology would flatten, causing the San Diego company's growth to slow. What's more, they predicted, Qualcomm would have to scramble to keep its technological edge in CDMA chips -- which account for most of its $4 billion in annual sales -- as competitors started to move into the market.

Instead of stumbling, though, Qualcomm has been scoring one slam dunk after another. CDMA carriers such as Sprint PCS (PCS), China Unicom (CHU), and Verizon Wireless -- a joint venture between Verizon Communications (VZ) and Vodaphone (VOD) -- have been signing on new subscribers at unexpectedly high rates, causing a run on cell phones and a mad rush of orders for Qualcomm's chips.

On Feb. 23, Qualcomm increased its estimates for the third time in the past year. After having predicted sales in its second fiscal quarter (ending Mar. 28) would grow no more than 8% year-over-year, Qualcomm now expects sales to grow 13%, to $1.2 billion. And it predicts earnings will jump 24%, to $378.4 million, or 47 cents a share. This performance has helped put Qualcomm on the lates BusinessWeek 50 list of the country's top-performing companies at No. 17.

UPSIDE LEFT. Investors have phoned in their votes of approval, driving Qualcomm's shares up to $67 and change from around $54 since the beginning of 2004. The stock has nearly doubled in the last 12 months. On Mar. 2, Qualcomm sweetened the pot for investors by upping its quarterly dividend 43%, to 10 cents per share.

Is it too late to get a piece of Qualcomm's fast-rising fortunes? Not necessarily. True, the stock is trading at a pricey 34 times fiscal 2005 earnings estimates. But Qualcomm's financials could have plenty of upside, especially if the long-awaited migration of most of the world's cellular carriers to W-CDMA -- a faster variant of Qualcomm's technology -- takes off toward the end of 2004, as many analysts say it could. Qualcomm gets an estimated 5% royalty of every CDMA device sold, and it supplies 90% of CDMA chips.

"There are a lot of drivers coming along with full force that could all of a sudden make Qualcomm's market much larger," says Robert Gensler, a portfolio manager of the T. Rowe Price. He says Qualcomm could achieve 20% annual earnings growth for the next five years. (T. Rowe Price owns shares of Qualcomm in many of its funds.)

NEW RIVALS. Investors should be wary of some significant risks Qualcomm faces. The first is the so-called "average selling price" (ASP) of cell phones, on which Qualcomm's licensing royalties are based. When the ASP falls, Qualcomm's royalty revenues fall. Lately ASPs have been holding steady, because strong sales of low-end phones in developing countries such as China and India have been offset by sales elsewhere of more pricey handsets that can take photos, shoot videos, and play games. If demand for those high-end phones falls, ASPs will drop, and Qualcomm will suffer.

Qualcomm is also facing competition in CDMA chip manufacturing. Last year, Texas Instruments (TXN) teamed with Nokia (NOK) and STMicroelectronics (STM) to make a line of CDMA chips that TI will market to other cell-phone manufacturers. TI has yet to score a major customer. Still, Qualcomm founder and CEO Irwin W. Jacobs isn't taking the competitive threat lightly. "It's probable they'll gain some share," he says. "We'll work hard to compete with them." (For a Q&A with Jacobs, see "The Handset as 'Very Powerful Computer'".)

The cornerstone of Jacobs' plan is to continue to lead his rivals in introducing innovative new CDMA products. Qualcomm is working on improving its chips, so they can support a host of nonvoice applications -- such as video, position location, and e-mail -- with as little battery power as possible. And Qualcomm has recently started selling "multimode" chips, which allow CDMA customers to use their wireless phones in cities that are powered by GSM, the prevailing European wireless standard.

GOT THE STOMACH? Qualcomm is also working on expanding its line of W-CDMA chips. "All this technology continues to evolve, and we just have to stay ahead," Jacobs says.

Investors who stuck with Jacobs so far have been well-rewarded. Those who can stomach the risk of an unpredictable and increasingly competitive wireless industry might want to grab onto his coattails now. If the father of CDMA succeeds in fulfilling the ambitious growth potential he envisions, shareholders may reap more gains down the road. Weintraub is a correspondent in BusinessWeek's Los Angeles bureau


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