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Qualcomm pushes chips, not phones
By Vanessa Richardson
September 17, 1999
To keep its sales and stock pumped, Qualcomm (Nasdaq: QCOM) will need guts. And "guts" -- communications chips and software -- happen to be what Qualcomm makes best. And now that it's unloading its signature cell phone products group, the company has more need than ever to find buyers for its wireless technologies.
On Tuesday, Qualcomm announced plans to sell its handset division by the end of the year in order to focus on the more lucrative business of selling wireless technology to manufacturers. Investors cheered the decision, boosting the company's shares 11 percent to a Wednesday close at $173.88.

A possible buyer for the handset division, Ericsson (Nasdaq: ERICY), announced Wednesday that it had no interest in buying the Qualcomm unit. Analysts say that leaves as possible buyers Korea's Samsung, Japan's Matsushita (NYSE: MC), Europe's Philips Electronics (NYSE: PHG), and Alcatel (NYSE: ALA), each with strong reasons for expanding their presence in the United States. "This is the best way for an overseas company to break into North America market and either enter or expand the CDMA market," says Merrill Lynch (NYSE: MER) analyst Michael Ching.
Despite comprising 45 percent of total sales, profits from cell phone sales barely contributed to the company's bottom line and are sinking fast. By contrast, chips and software have kept Qualcomm sailing. The company still must rethink its strategy, says Mr. Ching. "The whole revenue model will have to be recalibrated," he says. For now, losing the handset division shouldn't damage earnings.
In announcing the potential sale, Qualcomm affirmed its ability to meet analysts' expectations of 87 cents a share for its fiscal fourth quarter ending September 27. The company is on track because of steadily increasing royalties earned from other cell phone companies that use its patented CDMA technology. For its third quarter this year, such royalties generated $93 million, or roughly 10 percent of total company sales. Put another way, those royalties grew 97 percent compared to the same quarter last year.
Many analysts expect Qualcomm's CDMA to become the linchpin of a globally compatible line of "third generation" phones, which should help fuel the company's growth at an annual rate of 33 percent over the next five years. That promise has helped boost Qualcomm's shares 560 percent this year. "Why go through all the hard work of making the phones when you can just sit back and collect licensing fees from the other people who make the phones?" asks SG Cowen analyst Wojtek Uzdelewicz.
Qualcomm originally launched its CDMA technology against two other cell phone standards: TDMA and GSM. Now that CDMA is the standard in Korea and Japan, and is rapidly being accepted in the fast-growing U.S. market, Qualcomm thinks that reaping royalties from its widely adopted technology will generate profit enough.
"It's best for Qualcomm to focus on the fast-growth CDMA chip market, since it basically developed that technology," says Mr. Uzdelewicz. "The mobile phone market is one in which unless you have a volume of 30 to 40 million handset sales, it's very hard to have a profit margin."
In its third quarter ended June 27, Qualcomm sold 1.7 million handsets. But cell phone prices have been dropping faster lately, with 30 percent markdowns this summer compared to just 15 to 20 percent over the past few quarters. This has lowered Qualcomm's operating margins in handsets, which makes up half of total revenues, down to one to two percent. Nokia (NYSE: NOK) and Motorola (NYSE: MOT), by comparison, have operating margins of 19 percent and 10 percent, respectively.
The next step for Qualcomm is to get its CDMA chips into things besides mobile phones. It has a 90 percent share in that market, but competition will eventually drive that down to 65 percent, conceded Qualcomm president Rich Sulpizio at a Hambrecht & Quist (NYSE: HQ) technology conference last spring.
Because CDMA is already used in PalmPilots and smart phones, company officials think other wireless device makers will be easy to woo. Mr. Sulpizio stated that he sees no reason why the chips can't go into laptops and other wireless devices.
If Qualcomm is to make the transition from phones, that needs to prove true.

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