Where the Money Is in Wireless

S&P's Ken Leon says the sector looks strong, with mobile music and TV driving sales. His top pick? Motorola

Building on last year's strong handset sales, wireless equipment makers are betting that new mobile music and TV services will spark sales. Leading entertainment companies have been forging partnerships with wireless service providers to provide popular TV shows, music, and other content on handsets. "What will drive the industry is mobile TV and mobile music," says Ken Leon, who follows the wireless services industry for Standard & Poor's Equity Research.

Companies that stand to benefit are handset makers Motorola (MOT; ranked 5 STARS, or strong buy) and Nokia (NOK; ranked 3 STARS, or hold), as well as wireless chip maker Qualcomm (QCOM; ranked 4 STARS, or buy), Leon says.

BusinessWeek Online's Karyn McCormack recently spoke with Leon about wireless trends and his favorite stocks. Edited excerpts of their conversation follow.

Note: Ken Leon is a Standard & Poor's Equity Research analyst. He has no ownership interest in or affiliation with any of the companies on which he writes. All of the views expressed here accurately reflect the his personal opinions regarding any and all of the subject securities and issuers. No part of the analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this story.

What's the big focus for wireless equipment makers?

The opportunities we see are the explosive growth for wireless handsets and network operators moving to third-generation (3G) platforms. We see the most opportunity for those suppliers offering handsets such as Motorola, which is a strong buy, and Nokia, which is a hold, vs. the infrastructure vendors because the transition from second-generation technology to 3G is likely to be near completion at the end of 2006.

The wireless handset market had a very strong year in 2005, with shipments of 780 million or more, growing 21% above the level of 2004. Our global handset market forecast for 2006 is 905 million, which would be a 16% increase over the prior year.

Despite changes in worldwide demand for handsets, we see no significant change in the rankings of handset vendors by global market share. We expect Nokia to continue to maintain or boost market share because of its strong momentum in the emerging markets of China, India, Southeast Asia, and Latin America. Nokia finished 2005 with 33.5% market share, and its stated goal is to increase share to 34% (See BW Online, 2/7/06, "Nokia: Dialing North America").

Motorola finished 2005 with just under 20% market share, and we expect Motorola to gain one or two points of share in 2006. The other leading handset vendors are Samsung, LG Electronics, Sony Ericsson, and BenQ, which acquired Siemens' (SI) handset business last year.

Are there any exciting handset trends?

Color display, messaging, ring tones, and a camera are now standard fare. What's in for 2006 and beyond is music, video streaming, and enhanced camera display -- that is, above 2 megapixels, and e-mail capability (See BW Online, 2/13/06, "In Barcelona, the Future of Wireless").

What about mobile TV?

The first public announcement was Qualcomm's (QCOM) launch of MediaFLO, which plans to invest up to $800 million on a mobile network (not cellular) capable of offering real-time video. They are looking at a large list of entertainment partners for content. In January they announced Verizon Communications (VZ) as a partner for testing MediaFLO technology.

Another company worth watching is Crown Castle Mobile Media (CCI), which is developing a network for 2007.We're also seeing announcements from service providers partnering with traditional entertainment companies. Crown Castle announced their new venture, MODEO, to launch in 30 markets in 2007 using digital video broadcast technology.

Then there are service providers partnering with entertainment companies. Verizon has V CAST music and video services, and it signed up with ABC's Lost TV series. Cingular Wireless signed an exclusive contract with HBO called HBO Mobile and HBO Family Mobile. A company called MobiTV2 is offering a TV guide on your cell phone. Another key player for mobile TV is the partnership between Sprint Nextel (S) and cable multiple service operators (MSO), which has over 75 million households.

Among entertainment content companies, we've seen the launch of ESPN Sports Mobile as a wireless service. Disney Internet Group (DIS) said they plan to launch a mobile brand in the next few months for youth and families.

The two leading technologies for mobile TV are Qualcomm's MediaFLO and DVB-H, or digital video broadcasting - handheld, which is what Crown Castle will have. It's supported by Nokia and offers 20 video and 40 audio channels. It plans to launch MODEO at the 2006 World Cup soccer tournament in Germany.

One of the challenges of wireless broadband is whether video will have to be repurposed content to make the picture quality easier to fit handset devices and to make it less expensive to broadcast.

What about music?

While Apple's (AAPL) iPod has dominated the news on mobile music, we see wireless service providers and handset suppliers coming along with new products. Again, on the service provider side, Verizon's V CAST service has music as its centerpiece offering this year, and so does Sprint Nextel.

In both cases, a wireless subscriber can download a song for $1.99 to $2.50. Sprint expects to launch its service in the second half of 2006. Verizon Wireless has also announced three vendors to work on handsets with music capability: LG Electronics, Samsung, and UT Starcom.

We believe Motorola was disappointed with its first product, ROKR, which is capable of storing 100 songs, because it was overshadowed the same day by Apple's announcement about the Nano. Motorola will soon launch ROKR E2, which will be a more powerful handset capable of storing 500 songs. MP3 player suppliers like Sandisk (SNDK) will soon announce a 1 gigabit flash card for Verizon's V CAST service, so that a Verizon customer could store 32 hours of audio files, or 480 songs.

Which companies do you like in the group, and why?

The wireless equipment company we like best is Motorola. In our opinion, Motorola is well-positioned to expand its handset and broadband businesses. Motorola is the leading vendor to the cable services market and is the leading provider of handsets and networks to wireless. We believe that Motorola, with strong free cash flow and close to $15 billion in cash and cash equivalents at the end of 2005, can consider expanding its stock repurchase program or raise the dividend. Our 12-month price target for the stock is $28.

Motorola shares have had a nice run. What do you think will keep driving the stock higher?

We think sound execution on new products will be critical for improved earnings outlook. We believe recent weakness in the shares may be attributed to potential delays in the delivery of the RAZR phone to Verizon Wireless. The RAZR has been a big success with Cingular and other providers. Motorola is the No. 1 handset maker in North America, and No. 2 in the world, so its success with the RAZR is critical.

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