Qualcomm Assets Could Answer the CDMA Question at Nokia

Both stocks could benefit from an R&D deal that Wall Street is counting on.
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Mighty

Nokia

(NOK) - Get Report

has a little secret.

Though it's the global leader in wireless-phone sales, Nokia has lagged behind in the fastest-growing of the three digital wireless-phone standards: code division multiple access, or CDMA. So far that hasn't hurt Nokia shares, which have nearly tripled this year amid a furious telecom-stock rally that has pushed the

Nasdaq

a heart-pounding 78% higher for 1999. But investors see CDMA as a key market opportunity nonetheless, to judge by the performance of CDMA pioneer

Qualcomm

(QCOM) - Get Report

, which for 1999 is up an astonishing 1,880%.

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Now Wall Street expects Nokia to blot out its CDMA blemish with a deal that could be announced as early as this week. The speculation, which neither company will comment on, is that Nokia will acquire CDMA development assets from Qualcomm. A Nokia acquisition could remedy quality-control issues that analysts say have hampered its efforts to expand sales of CDMA handsets, sparking a further rally in shares of Nokia and Qualcomm. A deal would also present a challenge to No. 3 handset seller

Ericsson

(ERICY)

, which could find itself a cell phone also-ran, analysts say.

When Three's Not a Crowd

Qualcomm says it is on target to sell the handset division by year-end. Analysts speculate that Qualcomm is closing in on a three-way deal that would give Nokia the research and development assets and a Japanese manufacturer, either

Kyocera

or

Toshiba

, the handset business.

"That's the most likely scenario," says Alex Cena, who follows Qualcomm for

Salomon Smith Barney

. Cena has buy ratings on Nokia and Qualcomm, and Salomon hasn't done underwriting for either. Cena issued a report Monday calling the expected sale of the handset division a big plus for the stocks and possibly "a great coup for Nokia."

The deal would be advantageous for both companies, say analysts, because Nokia needs the CDMA engineering talent, and Qualcomm would likely see a surge in royalties as the top handset maker gets on the CDMA bandwagon.

Why CDMA Matters

Nokia leads the industry in sales of phones using the two competing wireless standards, time division multiple access and global systems for mobile communications. But "they suffer at making CDMA phones," says

Lehman Brothers

analyst Tim Luke, who has a buy on Qualcomm and Nokia. A deal with Qualcomm "would give them an immediate leadership position in CDMA phones," Luke continues. Lehman Brothers was lead underwriter of a recent secondary offering by Qualcomm, but hasn't participated in any banking with Nokia.

(A primer on wireless standards: In 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 in 1989, affixes a code on the packet of digital bits and spreads the delivery of the packets over a broad frequency spectrum. Receivers identify the code and pull in the intended string of packets.)

Though GSM and TDMA combined have 60% of the wireless market, many investors

believe CDMA is technologically more robust and will one day be the core of a global industry standard. So while Nokia has 25% of the world handset market, its 12% share of the CDMA market means it could be left behind in the most lucrative area of the market.

Motorola

(MOT)

has 15% of the overall handset market and Ericsson has about 10% of the market.

What Nokia Needs

Analysts say the big problem has been that Nokia has yet to master its own CDMA chips and software. Nokia's phones didn't test well in the labs, according to some of the CDMA operators, says

Dataquest

analyst Bryan Prohm, who hasn't done consulting for Nokia or Qualcomm: "That has been a problem for Nokia, mostly because they're adamant about using their own chip sets." Qualcomm, which developed CDMA technology for wireless phones, supplies more than 90% of all the CDMA chips and software in the market.

Nokia officials say they are pleased with their current CDMA offerings, and the efforts of their CDMA development center, a 500-employee research office in San Diego near the Qualcomm facility.

And though Nokia expects continued gains in overall phone sales, if it plans to dominate CDMA while still stubbornly relying on its own CDMA chips, then analysts say Nokia needs to bring the Qualcomm operation under its roof.

A Nokia with Qualcomm's engineers would be a formidable force in CDMA. Motorola's already got a strong position in CDMA through the popularity of its StarTac phones, but Ericsson has had difficulty cracking the market. And analysts say the Ericsson phones due out next year probably won't significantly help the company's third-fiddle position.

Zero-Sum Game

So while Nokia and Qualcomm could walk away winners in this deal, analysts say Ericsson would be one clear loser. The Swedish wireless equipment maker has been in the midst of a turnaround, and its shares have jumped a 50% in the past month, riding the mobile Internet wave. But Ericsson's handset division, which represents 20% of revenue, is still struggling.

Ericsson has said it expects 2000 handset revenue to rise 20%, but officials weren't available for comment on the impact of a possible deal involving Nokia and Qualcomm's R&D assets.

"It's going to be hard for Ericsson to keep its market share," says Prohm, "when the others have all their pieces in place."