Qualcomm: From Wireless To Phoneless

Can the company keep wowing Wall Street by selling research?

Irwin M. Jacobs is used to bucking conventional wisdom. A decade ago, the chairman and CEO of Qualcomm Inc. was pushing a wireless telephone technology that he thought would be more efficient than anything else on the market. But some of the most powerful companies in the wireless world, including Sweden's Ericsson, claimed that Qualcomm's technology would never work. Jacobs ultimately proved the critics wrong. He won the support of manufacturers such as Motorola Inc. and wireless phone companies like Sprint Corp. The San Diego company grew into a $4 billion powerhouse in the mobile telecom industry.

Now, Jacobs is going his own way again. Qualcomm is getting out of the manufacturing businesses that it worked so hard to build in order to focus on research and development. The company sold off its wireless network division earlier this year and expects to announce a buyer for its cellular-telephone business by the end of the year. In short order, Qualcomm-branded cellular phones will disappear from store shelves. About the only place the company's name will remain on public display is Qualcomm Stadium in San Diego, home of the Padres and Chargers. "Qualcomm has always been based on technical innovation," says Jacobs. "We'll let others deal with wrapping plastic around chips."

Instead, Jacobs, a former engineering professor at Massachusetts Institute of Technology, wants Qualcomm to be the wireless industry's best research lab. Already, the company has a slew of patents on things like how the sound of a voice is carried on radio waves to a cellular phone. Now, he wants to develop the next generation of wireless technology for everything from tapping the Internet to transmitting fat chunks of data. Qualcomm also will continue designing the computer chips that run mobile phones. One big potential hit is a new wireless technology, dubbed "high data rate," or HDR, that's capable of zapping video from the Net over radio waves. "We're way ahead" of the competition, says Jacobs.

His strategy has Qualcomm's stock zooming ahead, too. Its shares have soared nearly fourteenfold this year, the best return of any company in the Standard & Poor's 500 Index.

Here's why the bulls are stampeding. They believe that Qualcomm is set to become the Intel or Microsoft of the wireless world, a company whose hold on key technologies will deliver an endless jackpot. Today, only about 15% of the 257 million wireless phones worldwide use Qualcomm's key technology. But as the mobile market moves to Third Generation technologies that can transmit data at extremely high speeds, Qualcomm will take on a more prominent role. Analysts estimate that by 2005, more than half of the 1 billion cellular phones will use Qualcomm's technology. That could yield hundreds of millions of dollars in royalties annually. "They've got the core technology for the next millennium," says analyst Tim Luke of Lehman Brothers.

CRITICAL MASS? Yet Qualcomm's proponents may be missing something. Although the wireless phones coming out early next century will use Qualcomm's basic technology, it's not clear how rich its royalty stream will be. Wireless technology is evolving so quickly that it will be difficult for any company to keep a tight grip on intellectual-property rights. European rivals such as Ericsson and Nokia are designing mobile phones and wireless networks that bypass many of Qualcomm's patents. "More than 100 companies in addition to Qualcomm have Third Generation wireless patents," says Arja Suomenin, vice-president of Nokia Networks in Helsinki. "[Qualcomm does not] have more or less [patent rights] than others."

And there may be an even bigger problem. Just as Jacobs is whittling down Qualcomm, size is becoming increasingly important in the wireless world. The Big Three--Motorola, Nokia, and Ericsson--are gaining market share across their businesses. That's because they have tremendous resources to pour into everything from research and development to marketing. Qualcomm may be in a vulnerable spot if it has to rely on other companies to go out and sell its goods. "It's not a done-do success story," says Bob Egan, a research director at market researcher Gartner Group.

Consider the business of making chips for wireless phones. Qualcomm, which designs chips and outsources the manufacturing, now has some 90% of the market for chips using its technology, code-division multiple access (CDMA). As Motorola, Ericsson, Intel, and others pile into the CDMA arena, Qualcomm's share could slide to 50% by 2003, Merrill Lynch & Co. reckons. "Qualcomm has fundamental knowledge of CDMA, but it's going to have to run real hard to keep up," says Dwight M. Decker, chief executive of Conexant Systems Inc., a rival telecom chipmaker in Newport Beach, Calif.

Jacobs doesn't plan on just keeping up. By getting out of the manufacturing businesses, he figures Qualcomm will have enough resources to lead the pack in the development of wireless technologies. Consider this: With both the manufacturing divisions gone, operating margins will rise markedly. Merrill Lynch estimates they will jump from 7.6% in 1998 to 32.4% in 2000. Even revenues won't be hit that hard by the move, thanks to strong growth in chip design and licensing. Merrill reckons revenues will fall only 7% in 2000, to $3.67 billion

Qualcomm already is pouring money into what it figures are the wireless technologies of the future. Early this month, the company demonstrated HDR. While engineers tooled around northern San Diego in a white Ford Econoline van, they used HDR to pull up a TV-quality clip of Kevin Costner's For Love of the Game on a PC sitting in the back of the van. The streaming video is possible because Qualcomm is transmitting data over radio waves at astonishing speeds: more than 30 times faster than today's traditional modems. "Nobody else has achieved such speeds in a mobile environment," says Craig Ellingsworth, an analyst at Boston's Yankee Group Research Inc. who attended the demo.

TAKING ON BROADBAND. Wall Street was impressed. Qualcomm's HDR demo helped push its stock up nearly 60% this month alone. It sends data so fast that Qualcomm promotes it as a way for cellular operators to open a new avenue of competition against cable and phone companies' broadband offerings. Analysts agree that HDR's speed will leave the wireless-data solutions being developed by European competitors in the dust.

In the end, Qualcomm's new structure may result in even more dramatic change. Several analysts think that Jacobs has made the company more appealing as an acquisition candidate by selling the low-margin manufacturing operations. "It's beginning to look more like an engineering lab with lots of intellectual property that somebody is going to want to own," says Gartner Group's Egan. That somebody could be Motorola, Nokia, or even Intel, which is now getting into the business of making telecom chips. Jacobs is showing once again that blazing his own trail can be very lucrative for him and his shareholders.

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