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Qualcomm: A "Wireless Intel"?

By Olga Kharif Qualcomm began life in 1985 in a very unremarkable way -- in founder Irwin Jacobs' den. The space was small and crowded. The founding crew consisted of seven people, who were enthusiastic but low key.

Fast-forward nearly 20 years, and Qualcomm (QCOM), which licenses wireless technology and makes chips for cell phones, is still viewed by many investors as an upstart with modest ambitions and modest prospects. Yet with $3.85 billion in annual revenues, it's still struggling mightily to shake that image.

100% REACH? Some experts believe Qualcomm is on the verge of breaking into the big time. Short-term issues could pressure the stock in the next few months. But over the next decade, it could expand its market share of brainy chips inside cell phones from about 30% now to 80%. "Qualcomm could become the wireless Intel [INTC

]," says Michael King, an analyst with market consultancy Gartner in Carlsbad, Calif.

Alex Vallecillo, who oversees $7 billion in investments at Armada funds, agrees and says Qualcomm's stock price could mirror the rise of other tech giants, such as Cisco Systems (CSCO). How could this happen? Until about 1-1/2 years ago, Qualcomm was mainly known as the maker of code-division multiplexing (CDMA) chips. It also owns all patents covering the technology and receives significant revenue from licensing it to others. Still, with CDMA, Qualcomm dealt with only 30% of the world's cell-phone market.

That's changing. As phones based on a rival technology called wideband CDMA (WCDMA), allowing for high-speed data transmission, hit the market, Qualcomm has jumped into the action. By competing in both technologies, it can potentially reach 100% of the cell-phone market.

OPEN TO SAMPLING. Experts say Qualcomm's long-term goal of a 50% share in WCDMA, up from today's less than 10% share, isn't a pipe dream. Merrill Lynch analysts believe that even if Qualcomm achieves only 30% share by 2007, as that market grows from 14 million to 204 million WCDMA chips shipped annually, earnings per share might easily swell from $1.20 in fiscal 2005 to $1.75 in 2007. That's 46% growth over two years, which, for a business this size, isn't easy to find.

Qualcomm owns about 35% of the new technology's patents, figures King. That means pretty much anyone building WCDMA cell phones owes Qualcomm royalties. Already, WCDMA license fees contributed 25% of royalties in its latest quarter, ended June 27, up from zero only two years before. Analysts expect the amount to keep rising.

Second, Qualcomm already has established relationships with phone makers like Nokia (NOK) and Samsung, which might be willing to try Qualcomm's WCDMA chips. On Oct. 19, it announced that handset-maker Siemens (SI) will build cell phones around its WCDMA chips. "The fact that Siemens chose us will cause other companies to at least look at Qualcomm," says Paul Jacobs, executive vice-president.

Qualcomm also has long-time ties to most of the world's wireless service providers, which buy phones with its CDMA chips and, thus, might be open to sampling its WCDMA efforts. On Oct. 7, Qualcomm announced joint WCDMA phone development with Japanese NTT DoCoMo, recognized worldwide as a pioneer in mobile services.

GRAPHICS EDGE. What's more, as cell phones increasingly incorporate features like digital cameras, camcorders, and gaming capabilities, Qualcomm might increase its share of a phone's chip and software content, grabbing revenues from consumer-electronics companies and software makers. "Qualcomm is in the process of becoming a mobile multimedia company," says John Bucher, an analyst with Harris Nesbitt in Los Angeles, who says he's considering buying the stock.

On Oct. 12, it acquired British startup Trigenix, offering consumer mobile-interface software. The idea is to strengthen Qualcomm's BREW mobile software platform, to make it easier to buy services such as games over a phone. A better interface might allow consumers to do so with a push of one button instead of navigating through a set of confusing menus, as is the case today. That could boost mobile-content sales.

Qualcomm is also working to integrate ATI Technologies' (ATYT) graphics chip, which enables 3-D gaming on computers, onto its mobile chip. The resulting component, expected to become available in about two years, would give cell phones a gaming console's ability to handle supercool graphics, says Qualcomm's Jacobs. Another chip, to become available in 1-1/2 years, would allow wireless users to beam photos snapped with their phones' digital cameras to a nearby TV set for viewing.

NEAR-TERM HEADACHES. Longer term, Jacobs even foresees adding mobile digital-rights management to Qualcomm's chips. That would mean users might rent a movie by downloading the film onto their mobile phone. Then they might watch it by pointing their handset at a TV. Or, they might watch it directly on their phone.

In either case, a Qualcomm chip in the phone would "remember" how many more days of rental the user has left. "People are going to be more and more blown away by the possibilities of what this thing called a phone can do," says Jacobs.

Still, it faces brutal competition in the years ahead, most notably from mobile-chip maker Texas Instruments (TXN). On Oct. 21, TI announced plans for chips for cell-phone-based digital TVs. They should be deployed in volume in 2007, says Marc Cetto, a general manager of TI's handset business. TI is also continuing to aggressively cut costs and prices of its WCDMA chips to stop Qualcomm from grabbing more share. That's why Ren Zamora, an analyst with Loop Capital Markets in Chicago, worries that this price pressure could result in falling margins and lesser revenue growth for Qualcomm than currently expected.

RALLY OR SELL-OFF? Some near-term issues could cause problems for Qualcomm as well. One is a noticeable slowdown in China and India, which used to be the world's fastest-growing wireless markets. Furthermore, Qualcomm continues facing supply constraints on certain chips. Execs say they plan to expand their network of manufacturing partners to be able to better meet future demand.

A further concern: Qualcomm might soon change its accounting for royalties, contributing 34% of total revenues, as WCDMA royalty sales are harder to predict than CDMA royalties are. If the change does go through, it might report a one-time, $298 million revenue reduction.

At $42 a share, Qualcomm's stock is near its 52-week high of $44.40. Some analysts believe it would be a better buy in mid-$30s, while detractors think the stock is due for a sell-off because of the near-term issues. But Vallecillo and others believe this is one stock due to appreciate considerably in the long term. They're betting that its climb to the top may be just starting. Kharif is a writer for BusinessWeek Online in Portland, Ore.

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