Thursday, January 31, 2008
I am not sure what the final outcome of these talks will be. It appears that the best route for both companies and also for a faster deployment of WiMAX in the US. Perhaps, Sprint will spin off the WiMAX business so it can focus on its ailing CDMA business. It is already looking to write off $31 billion in goodwill. In the meantime, all of us will have to hear Sprint and Clearwire tell each other, "I love you, I love you not..."
You can read some opinions and analysis in this reuters report. While this is not necessarily surprising in the wake of Mr.Icahn's position, I do wish to note a few points -
- The largest US handset maker may potentially get acquired by an Asian/European competitor. This can weaken US's position in the wireless/telecommunications industry. Further, its position as the US market leader is an extremely attractive proposition to other vendors.
- In the case of an acquisition by a non-US company, I can see QCOM's position strengthen internally. As a handset vendor, Motorola had vested interests in keeping QCOM at bay in the wireless standards. If the company ceases to exist in this space, then QCOM will likely get unconditional backing from the US wireless industry and perhaps the government as well.
- With Nokia unlikely to be a buyer, it is further good news for QCOM in terms of increasing its market share. If it is any indication, the recent announcement from Motorola that it will go with QCOM 3G chipsets may be a deliberate positioning effort to bring in more suitors. LG or Samsung will perhaps be most ideal for QCOM's fortunes.
- Chinese vendors who are having a growing clout in the industry, may post heavy bids to emerge as bigger forces effectively redefining the industry's geopolitical alignment.
- I can also think of dark horses like Google as buyers.
- While a spin-off itself may be good for the other two profit-making ventures, it will also enable the new entity to focus on winning back some market share.
As I looked at the positives of QCOM acquiring IDCC, I threw a number between $35 and $45 as a possible sale price. This price was based on a mix of historic data projection, IDCC’s current stock price and the perceived value to QCOM. I revisited the topic recently to do a more thorough valuation analysis which I will present over the next few articles.
As with my QCOM valuation, I have chosen the path of an event-based discounted cash flow analysis since it allows me to superpose the company’s position in the industry’s future. Further, the lucid picture steers clear of multiples based on the peer group in the technology sector. The valuation for companies like QCOM and IDCC which thrive on intellectual property licensing cannot be fair if it is based just on peer comparison.
This being said, the valuation of IDCC has been a challenge due to a variety of factors –
- Percentage of IDCC-licensed handsets is unclear: The company claims that 30-35% of 3G handsets have IDCC licenses currently. I do not see this number as sacrosanct. So, it is difficult to linearly predict their growing customer base.
- Lumpsum fees versus per-unit royalty: IDCC reports that 60% of its revenue comes from 3G handset sales. It is unclear if lumpsum payments made for 3G licenses like in the case of LG fit into this category. I am going with the assumption that it is.
- Royalty rates are not linear as is the case with QCOM: IDCC seeks a per-unit royalty subject to a cap. This makes it difficult to map royalty as a percentage of the handset ASP. Based on the revenue share data and the 3G market share IDCC claims, the per-unit royalty is a little over $2 currently. But with larger volumes to be shipped in the years to come, this number will certainly come down.
- The legal uncertainties: Due to the volatile nature of the IP business, it is very difficult to predict when the licenses will materialize. This in turn determines the company’s market share. This also makes the company’ primary growth driver – 3G boom – more unpredictable.
- Chipset business: IDCC’s ASIC business is a new kid on the block and its success is yet proven through major customer wins. IDCC has however completed successful performance trials and has to now draw the carrier and handset vendors’ attention to its solutions to obtain design wins. These design wins will in turn give us more concrete market share data on the company.
- Secondary growth: As I have always maintained, with a flatter patent play in OFDMA, the growth rates will be stinted with just the current model. The company will have to transition its ASIC division into a staple revenue source. Any design win will not only give it a good push right now, but also serve as the platform for the company’s secondary growth beyond 2012 when the OFDMA technologies will slowly start to make inroads.
- Expenses: The current operating expenses as a percentage of the revenue are not indicative of the long-term picture. The CAGR of the operating expense is equally misguiding. IDCC is pushing a lot of money and resources into its R&D program, primarily to develop its 2G/3G ASIC. I think that while the R&D expenses, SG&A and its sales and marketing costs will grow at about 17% to expand its engineering team, its IP related fees should flatten out. I anticipate a net 15% increase in its year-on-year operating expenses.
In the sequel, I will briefly go over some of my assumptions and rationale and later take a look into my valuation.
Wednesday, January 23, 2008
Motorola announced, along with its grim financial results, that it will use QCOM chipsets in its UMTS phones. The new CEO, Greg Brown, may have played a key role in Moto's change of stance on QCOM which it shunned just a few months ago. I had written on November 5th, 2007 -
"Look who is back: As data takes the forefront, and modem performance becomes more important, some vendors who have looked away from QCOM may come back. The QCOM receiver is perhaps the most advanced, thorough, stable and well tested product out there. With R&D two generations ahead of the competition, the engineering superiority is never in question. The caveat is a slight change in the heart of the QCOM management and a reduced royalty rate. And I think both of these are good for the company in the long run as it strives to get more chipset market share. We may see Motorola coming back to QCOM for 2010 and beyond. And who knows, maybe Nokia too!"
It seems Motorola is doing so even for 2009. This is certainly big news for QCOM. In my note on QCOM's valuation, I had mentioned "The valuation of the QCOM stock with Gobi in the picture goes up to $52. Motorola coming back to its fold can also raise valuation to the same number." Effectively, a sustained partnership, not to mention the chances of Motorola regaining market share with its superior performance, is worth a few billions to QCOM and boosts its valuation by about $6.
For Motorola, it no longer needs to worry about performance superiority and can now focus on software, GUI and other issues that have bogged the sales of its phones. Of course, the modem itself is only one of its worries. Nokia is the market leader by a mile because it understands the pulse of the emerging markets like no other handset manufacturer. The indigenous designs that cater to almost all segments of phone buyers is yet to be matched. Motorola will have to work on these macro parameters if it wishes to make the best use of the best modem out there.
Paul Jacobs remarked that cell phones are ``not a luxury, they're a staple.' This strengthens the case of cell-phones despite concerns of an economic downturn. The Motorola alliance adds to QCOM's strength and resilience. It is a firm pointer to the company's survival in the wake of a recession.
Sunday, January 13, 2008
Will Qualcomm acquire Interdigital? This was the question I raised in my last article. I will try to take a quick look at the feasibility of such an event in this part of my series.
Interdigital has a market cap of about $1 billion today. The stock closed on Thursday, January 10 at $21.47, which is relatively low when compared to its 52-week high of $35.74. If my iPhone speculations are true, I anticipate that the company’s stock will climb back to these numbers when the iPhone V2 is out later this year. The strengths of this number include its per-unit royalty from its Infineon alliance and the ASIC business. The risks include the sustenance of the ASIC business and the litigations. I also think that if this deal were a reality, Qualcomm may have to cough up between $35 and $45 a share amounting to a deal worth $1.75-$2.25 billion.
The numbers certainly look staggering, but perhaps not for Qualcomm. The company closed on January 10th at $37.99 with a market cap of about $62 billion. Interestingly as of Sept 30th 2007, Qualcomm had cash and equivalents of $2.4 billion and short-term investments of another $4.17 billion. So, the San Diego-based company can certainly afford a big acquisition. The question is why should it acquire Interdigital and will it do so?
Why should it Acquire? Let me try and bring out the financial impact to Qualcomm here. Interdigital traditionally licenses its IP for a flat-fee. On the other hand, Qualcomm charges per-unit handset royalty as a percentage of its average selling price (ASP). The exact proportion of the ASP that Qualcomm will receive is the center its ongoing battle with Nokia. If Qualcomm acquires Interdigital before any such deal is finalized, it will get an upper hand in the discussions. A 1% higher licensing rate from Nokia is worth about $2.4 billion to Qualcomm. This figure, even when discounted at 8%, is worth about $1.9 billion. 1% may be on the higher end of a gain from IDCC’s IP portfolio to Qualcomm. But I have used these numbers to illustrate the higher worth these patents could be to the licensing model of Qualcomm than to IDCC itself. If Qualcomm is certain that the acquisition can guarantee such ballpark numbers from Nokia alone, the decision then will almost be a no-brainer.
Will it acquire? I am sure it will if it needs to. For one, Qualcomm has, in the past, never hesitated to make big acquisitions. Its 2000 acquisition of SnapTrack for its GPS capabilities is a good example. The company paid $1 billion in stocks to the San Jose-based SnapTrack for close to 50 essential GPS patents and its engineering team. Similarly, it paid a comparable amount to acquire Flarion in 2005 for the OFDMA patents and the team. While Interdigital does not bring in new technological capabilities like the other two did, the King of Prussia-based company certainly has the complementary IP portfolio that Qualcomm would love to have. Besides, with its recent spree of acquisitions, Qualcomm has sent a clear signal that it wants to expand and strengthen its leadership position. So money will certainly not be an issue if Qualcomm determines that Interdigital adds value to its profile.
It is true that my excitement about Interdigital is very speculative, especially with respect to its iPhone involvement. But that will only affect its valuation and hence the price for an acquisition. However, I am certainly confident that the synergies from this acquisition, if it happens, can cement Qualcomm’s future while stabilizing its current position.
The genesis of my question is perhaps the synergies that I found hard to ignore between the two companies –
- The complementary intellectual property (IP) portfolios: The two companies are often in the news due to their legal wranglings. Interdigital recently won a English High Court ruling against Nokia that one of its patents is essential to 3G UMTS WCDMA. With Nokia already locked in a licensing war with Qualcomm, Interdigital patents can only create more value for Qualcomm.
- iPhone and the other smartphones: Qualcomm is the wireless chipset market leader. The iPhone can be its crown jewel. I am sure the company is trying hard to be part of future iPhones. Apple’s propensity to maintain its technology innovator can help Qualcomm’s cause. But as I mentioned in my previous articles, I see Infineon and Interdigital in the 3G iPhone. Besides, Interdigital is slowly making progress in the smartphone market. An acquisition will strengthen and expand on Qualcomm’s leadership position. It will provide a vital segue for Qualcomm as it tries to sell to Apple and the others in this segment.
- Competitive chipset market: Interdigital’s long-term survival as a stand-alone company in the industry is based on the sustained success of its ASIC business. If this initiative fails, the company will die a slow death as 3G gives way to OFDMA-based systems. On the other hand, it can leverage on Qualcomm’s engineering excellence, quality assurance and customer support capabilities to provide its own customers cheaper and better products.
- New offices for Qualcomm: An Interdigital acquisition will usher in more dynamic engineering talent that Qualcomm is always open to. One of the key factors behind the Flarion acquisition apart from the OFDMA IP, was the new blood it brought with it. The teams at King of Prussia, Melville and Quebec will also bring with them diverse experience and office culture that is vital as Qualcomm looks to grow further. Being part of the Qualcomm legacy will not only be a great learning experience for the Interdigital engineering teams in the east but will also lend substantial credence to their work.
- Legal teams: The legal teams can complement each other. Besides, some fresh faces with very relevant experience can certainly help Qualcomm in light of the negative publicity that its legal team has been receiving recently.
My list is not a comprehensive set of synergies but rather pointers to a potentially strong acquisition. Also, at the moment, I don’t see major negatives in such an alliance. However, the question in my mind is the feasibility of such a deal. I will try to answer this question briefly in a sequel. In the meantime, given these synergies, what do you think about a potential Interdigital acquisition by Qualcomm?