Like Its Stock, Qualcomm's Technology Takes On a 'Life of Its Own'

CDMA appears to be the superior standard but is far from assured of a dominant position, analysts say.
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A key driver of

Qualcomm's

(QCOM) - Get Report

astronomical

rise this year is the assumption that its superior technology will prevail over better-positioned competitors.

The belief is that Qualcomm's code division multiple access wireless technology will inevitably become the industry standard. That status would bring Qualcomm, which develops CDMA chips and has sole claim to all royalties from CDMA chip and handset licenses, tons of dough.

But industry standard races are rarely easy, and the best technology doesn't always win. Remember VHS vs. Beta? Windows vs. Mac?

And in this contest, CDMA is far behind, with about 10% of the global market, according to

Yankee Group

, a Boston research firm that has consulted for Qualcomm. Three years from now, CDMA will have all of 15% market share, Yankee Group predicts.

It's also possible that there won't even be a true global standard for another 10 years, if ever. Even if CDMA emerges as a key piece of a global standard, it'll be difficult for Qualcomm to hold on to its estimated 5% royalty take, analysts say. And for a company that's shedding its manufacturing businesses to focus more on research and collecting licensing fees and patent royalties, that 5% means everything.

So given all this -- and the little fact that Qualcomm's shares have soared some 1,450% this year -- the stock looks, well, ahead of itself. Qualcomm declines to comment about its stock price.

Leaving the Flock

Three analysts have recently downgraded Qualcomm to a hold, including Dave Powers, an analyst with

Edward Jones

who issued his new rating late last month because the stock's run-up was "ahead of underlying fundamentals." (Edward Jones hasn't participated in recent underwriting for Qualcomm.)

Powers says

momentum investing, stock-split euphoria, a short squeeze and the

Nasdaq

buying frenzy all have contributed to Qualcomm's overvaluation.

At midday Tuesday, Qualcomm shares were up 9 1/4, or 2.3%, to 404. At that price, Qualcomm's market capitalization is around $66 billion and its price-to-earnings ratio is 318.

Of course, Qualcomm concedes CDMA might not become the global standard. "Nothing in this world is guaranteed," says a Qualcomm spokeswoman. "But we believe that our patents definitely apply to any 3G standard based on CDMA," referring to the so-called third-generation wireless standard that analysts say might prevail within a decade or so.

A study committee of the

International Telecommunications Union

, a

United Nations

-sponsored tech standards board, has recommended that three CDMA-based standards be adopted as the future third-generation standard. The ITU may vote on the recommendation as early as next month.

But the market may not listen to the ITU, and there's plenty of competition for it to choose from.

Crowded House

The trade associations representing the two top systems -- time division multiple access, or TDMA, and the TDMA-based global systems for mobile communications, or GSM -- formed an alliance in February to cooperate on a compatible standard for Internet access and other data services, building an even more formidable competitor. (With GSM and TDMA, conversations are broken up into digital bits and sent on timed intervals -- hence time division. CDMA, which was originally developed by the military and applied to consumer use by Qualcomm starting in 1989, affixes a code on the packet of digital bits and spreads the delivery of the packets over a broad frequency spectrum. Receivers can identify the code and pull in the intended string of packets.)

"They have some technological advantage, but it's not clear in the long run that they have the only wireless standard," says David Clott, a money manager at

Commercial Union

, a U.K. insurance and investment firm. "If application developers are working on the

TDMA standard, it could mean trouble for Qualcomm." Clott has no position in Qualcomm, though he holds

AT&T

(T) - Get Report

and a number of the regional Bell companies that could compete with Qualcomm.

3G Glasses

"With the hype and anticipation so high right now, the whole 3G thing has taken on a life of its own," says Brian Cotton, director of telecommunications consulting for

Frost & Sullivan

. But a lot can happen between now and then, he says. "There are a lot of smart people working on a lot of potential magic bullets," says Cotton, who hasn't consulted for Qualcomm but has consulted for its competitors

Lucent

(LU)

and

Ericsson

(ERICY)

.

Cotton says the top telecom technology companies such as Lucent, Ericsson and

Nortel

(NT)

could easily create a critical piece of the 3G infrastructure and use it as leverage against Qualcomm. In the worst-case scenario, Qualcomm could have to share some of its licensing revenue to be a part of the killer networking solution, says Cotton.

Still, other analysts say that may be a misreading of who really holds the power. While the infrastructure developers create the playing field, Qualcomm's CDMA is carrying the ball.

"The bears would say they won't get any royalties, but I think they will, though they will probably get diluted," says the manager of a major hedge fund who asked not to be identified but holds a large Qualcomm position. "But even if it is diluted, you are talking about a market that is going to be enormous."

Maybe. But given the technology's rapid innovation cycle, Qualcomm's CDMA world dominance is anything but a sure bet.