Chipping Away at Qualcomm's Chips

Rivals are going after its near-monopoly market. Is this the end of its growth spurt?

Whenever Qualcomm Inc. CEO Irwin M. Jacobs goes to a party, he whips out his cell phone, uses it to videotape the other guests, and then plays the clips back for them on the phone's full-color screen. At this year's Super Bowl, held at Qualcomm Stadium in San Diego, he used the party trick to wow California Governor Gray Davis. Jacobs likes to boast that while Samsung Electronics Co. manufactures the phone, the Qualcomm chip inside is what makes the video and other wireless wizardry possible. "Whenever I show the phone off, everybody wants to know where they can buy one," Jacobs says.

The 69-year-old CEO has reason to gloat. Qualcomm has a near-monopoly on CDMA, a digital standard for handling mobile-phone calls that's surging in popularity around the world. Qualcomm sells 90% of the chips that power CDMA phones, and it earns royalties on every CDMA device sold. CDMA is expected to grow from 20% of the total wireless-phone market last year to 25% this year. That tailwind should help Qualcomm's sales to rise 30% this year, to $3.9 billion, while earnings jump 42%, to $1.1 billion, according to analysts' estimates.

Still, Jacobs won't be able to spend all his time partying with politicos. In recent months, two heavyweight rivals have unveiled plans to break Qualcomm's lock on the CDMA semiconductor market. Samsung, one of Qualcomm's biggest customers, recently said it will begin making its own CDMA chips to put into some of its mobile phones. And on May 15, Nokia, the world's largest manufacturer of cell phones, said it would team up with chipmakers Texas Instruments and STMicroelectronics to make CDMA chips for its newest phones.

The double-barreled assault is serious. Nokia and Samsung make nearly half of the 425 million cell phones sold in the world, so they have the muscle to affect market share and prices. On top of that, Texas Instruments plans to market modified versions of the CDMA chip it's developing with Nokia to other cell-phone makers, such as Motorola, LG Electronics, and Kyocera (KYO ). "The market is crying out for some alternatives," says Tom Pollard, worldwide chipset marketing director for TI. "CDMA [phone] pricing is higher than other wireless standards. That comes with the territory when you have only one chip provider."

The cost of two giants looking to eat Qualcomm's lunch could be high. Analysts say Qualcomm's share of the CDMA chip market could fall from 90% to 80% in 2004. "It will be difficult for Qualcomm to grow at all in '04," says WR Hambrecht & Co. analyst Peter C. Friedland. The new competition likely will hit profits, too. Deutsche Bank (DB ) analyst Brian T. Modoff expects the average $21 price tag for a Qualcomm chip to drop 15% over the next year. He is forecasting that Qualcomm's sales and earnings both will fall slightly in 2004, to $3.6 billion and $960 million, respectively.

Troubles in China and India, two of Qualcomm's most promising markets, could exacerbate the company's challenge. In China, the SARS scare has kept potential cell-phone buyers homebound. "That took a month's worth of selling out of the cell-phone market," says Jacobs. In India, the largest CDMA carrier, Reliance India Mobile, says they have attracted 1.1 million subscribers. But some analysts suspect the number is closer to 800,000, which could lead to lower sales and price cutting in the future. Because of excess inventory in both countries, Qualcomm warned analysts in April that chip shipments for this quarter would be on the low end of the 23-million-to-25-million range it had expected.

Jacobs vows that the company, often underestimated in the past, won't lose its edge. As part of his plan to keep Qualcomm on a hot streak, he is preaching the advantages of CDMA overseas in hopes of increasing the company's presence in such new markets as Indonesia and Thailand. On June 3, Qualcomm said it would invest $100 million in Chinese companies making CDMA phones and other products. And Qualcomm is pledging to keep its edge in technology. On May 22, it unveiled several new chip products designed to let manufacturers pack more multimedia features into phones at lower cost. And they're less power-hungry, which should help improve battery life on CDMA phones.

How will Qualcomm fare in this newly competitive environment? While market share and profits may take a hit, the company is likely to be a strong player in the years ahead. The key reason: The CDMA market is growing so fast that even if Qualcomm loses some share to rivals, its revenues likely will continue to head north after 2004. Research firm Herschel Shosteck Associates Ltd. estimates that CDMA phones will grow to 47% of the total market in 2007 from 25% this year. "The long-term picture is bright," says Rob Gensler, manager of T. Rowe Price Media & Telecom Fun (d PRMTX ) which owns 5 million shares of Qualcomm.

To stay ahead of his competitors, Jacobs plans to increase the pace of innovation. The company is coming out with a host of new products that are likely to command premium prices. One of them would allow CDMA users to roam almost anywhere in the world, something that can't be done today because of conflicting wireless standards. "Qualcomm's chips have a level of integration that goes above and beyond what [competitors are] offering," says analyst Rich Valera of Needham & Co.

Qualcomm also is angling for a leading position in the world of next-generation phones. It has developed a technology called EV-DO, which lets CDMA carriers transmit data at blazing speeds. Forget about e-mail or stock quotes -- with EV-DO, customers can watch streaming video on their mobile phones and laptop computers. "Our customers are thrilled with the speeds," says George Tronsrue, CEO of Monet Mobile Networks, which provides service in Minnesota, Wisconsin, and North Dakota. Verizon (VZ ) Wireless, a big Qualcomm customer, will launch EV-DO systems in Washington and San Diego this summer.

Jacobs is even getting into the software business. In 2001, Qualcomm launched a product called Brew that lets software developers make games and other multimedia applications that CDMA subscribers can download to their phones. Qualcomm gets a cut of the fee carriers charge subscribers who use the programs. One of the newest Brew products is QChat, a technology that will enable CDMA phones to operate like walkie-talkies, much like the push-to-talk service that Nextel has marketed successfully to construction workers and other tradesmen. Jacobs' son, Paul, who manages the Brew unit for Qualcomm, says some wireless carriers plan to launch QChat next year, though he won't disclose which ones.

Brew does face stiff competition from other wireless data standards, notably Java software. Verizon, Alltel (AT ), U.S. Cellular (USM ), and five overseas carriers have adopted Brew. But the other large U.S. CDMA carrier, Sprint PCS Group, has yet to sign on. "They started down the Java path early, and it has been difficult for us to change that momentum," says Paul Jacobs. He concedes that Brew may not break even this year, as predicted, and he isn't sure when it will turn a profit.

The elder Jacobs isn't deterred by the challenges ahead. He believes that CDMA technology can double its worldwide presence over the next few years, and his company will lead the pack. If he wants to see a vision of the future, he just reaches into his pocket and pulls out his videophone with its Qualcomm engine.

By Arlene Weintraub in Los Angeles, with Manjeet Kripalani in Bombay and Moon Ihlwan in Seoul

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