Wireless Industry Analyst

• 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.

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 10^th at $37.99 with a market cap of about $62 billion. Interestingly as of Sept 30^th 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?

So far, I have presented an argument for why Interdigital stands to gain from the iPhone. Early this fall, the company signed a 7-year licensing agreement with Apple. Here is my interpretation of the license –

• The license is retro-active to the day one of the iPhone. This implies that Apple is also paying for 2G technology licensing. So, the $2 million increase in its guidance around September (which analysts speculated was due to the Apple deal) was from licensing 2G technology alone.
• Interdigital has traditionally used the flat-licensing fee model. This has perhaps led analysts to interpolate the $2 million. They now speculate that the company’s earnings per quarter from Apple will be capped at $2 million thus yielding $56 million over the 7-years of the license agreement. Fair enough! But the catch is that with the 3G iPhone, Interdigital not only gets a flat licensing fee (per its IP licensing model) but also makes a PER UNIT ROYALTY for every Infineon platform sold. Besides, the licensing fee for 3G is also likely to be higher as it encompasses both 2G and 3G IP.
• Here are some rudimentary calculations I came up with. If Apple gets 1% market share and sells one 3G iPhone for two 2G iPhones it sells in 2008, then at $2 per handset, Interdigital can make $8 million for the year just out of handset sales. This number can only increase with the 3G sales looking to exponentially increase in 2009 and 2010. So, for now, it is hard for me to believe that the Apple deal is worth only $56 million for Interdigital.

Well, that is my speculation! I will closely watch the company’s quarterly numbers and of course, the release of the next iPhone to see if my analysis is right.

The fourth part of my Interdigital series on Sramana Mitra's site.... Some of it is a re-cap of what I had written over three months ago here.

I concluded the last article in this series postulating that Interdigital will stand to gain not only from the licensing of essential patents to Apple but also from individual iPhone sales. To reason this out, let us take a quick look at the Infineon chipset in the current iPhone design-

The platform used was Infineon’s MP-EU. The platform itself supports UMTS (3G WCDMA FDD).

• Contrary to a myth, the current iPhone does not support 3G that can be enabled by a software switch. The chip used, SGOLD2-8876 is only capable of EDGE (a 2G enhancement). So, despite the platform’s capability, the iPhone is limited by the chips in it.
• MP-EU has Interdigital 3G protocol stack and baseband design and the King of Prussia-based Interdigital stands to get royalty for every 3G phone using the platform.

Based on this information, if Apple continues to use MP-EU for its next generation, upgrading its baseband chip alone to support UMTS, then Interdigital will immediately start to get per unit royalty. Of course, MP-EU does not support data-centric HSDPA which will give a better mobile internet experience. Infineon’s next generation chipset MP-EH supports HSDPA also and is covered under the 2006 expanded agreement with Interdigital. I think that MP-EH, along with S-GOLD3H, the HSDPA baseband solution that Infineon sampled last February is a good iPhone V2 candidate provided performance and interoperability issues are ironed out. There are at least two reasons that come to my mind when we seek to speculate on the heart of the next iPhone -

• Apple already has the MP-EU in the market and is testing it for stability and optimizing it for performance. The Marvell Wi-Fi solution had performance issues that were quickly ironed out. Similarly, Apple is conscious of the power consumption of the Wi-Fi chip and its effect on the total battery-life. I am guessing that the iPhone creators are already working to address such issues in the current platform. So, they are unlikely to prefer a new solution, at least in the short-term. In fact, in the absence of a stable HSDPA solution from Infineon, Apple may still opt to come out with just a WCDMA/UMTS version. This will require minimal changes to the current platform.
• The total cost of MP-EU and the 2 IFX chips in the iPhone is speculated at close to $16. Infineon can potentially offer Apple its 3G solution at a comparable cost (perhaps ~$20).

In summary, I speculate that Infineon will continue to be in the iPhone and therefore Interdigital also stands to gain substantially. In the sequel, I will take a quick look at my interpretation of Apple’s deal with Interdigital.

The alliance with Infineon has been a rather crucial one for Interdigital. The companies have been working together on 3G technologies in a strategic relationship since 2001. Last year, there were two important pacts that strengthened this alliance –

• Infineon licensed its GSM/ GPRS/EDGE S-GOLD 3 baseband modem and protocol stack software from subsidiary Comneon to InterDigital. This essentially allowed Interdigital to produce its own chipsets with 2G and 3G baseband modems. The agreement gives Interdigital the right to use Infineon’s 2G technology in its own modem offering or to sublicense the technology to third parties developing their own 2G/3G modem offerings. This deal facilitated the company’s ASIC plans in the 3G space. Interdigital successfully conducted initial evaluation tests on this combined 2G/3G modem with a state-of-the-art HSDPA advanced receiver solution this month. While Interdigital continues its march towards the smartphone market, Infineon will benefit from the licensing of components of the modem, the complete design, and of course, the sale of ASICs.
• In January, the two companies expanded their relationship to incorporate HSDPA development as well. Under this expanded agreement, the companies will continue the joint development of the 3G protocol stack software technology for Infineon’s 3G platforms. This agreement expanded the collaboration to include the data-centric HSDPA as well. This agreement also “amends the per-unit royalty rates to be paid to InterDigital for the sale of Infineon’s ASICs containing jointly-developed protocol stack software.”

While the first agreement gives Interdigital a foothold in the highly competitive ASIC world, the second agreement is also fundamental for its future outlook. Here is why –

• Interdigital gets a share for every Infineon 3G chip sold world-wide
• Infineon’s 2G chipsets are in today’s phones, most notably the iPhone

So, if iPhone V2 which will arrive in 2008 has the Infineon chipset, then Interdigital will stand to make money from every iPhone sold world-wide. In the sequel, I will look at why this is likely to be the case.

2007 has been a happening year for the wireless industry. Apple’s iPhone and Google’s Android are just two examples of how even outsiders want a part of this very luscious pie. 2007 was eventful for another reason – the legal battles between two American communication devices manufacturers – Qualcomm and Broadcom. I have drawn from the legal wrangling between these giants to dissect the future of Qualcomm. In the coming weeks, I hope to similarly review the fortunes of Broadcom. It will be good to start with a perspective on the company’s strengths and weaknesses.

Broadcom was started in 1991 by Prof. Henri Samueli from UCLA along with Henry Nicholas III, a former student of his. As its name indicates, it was started with the idea of selling broadband communications solutions. It is illustrative to take a quick look at Prof. Samueli’s background to understand the strengths of Broadcom as a company. He founded Broadcom to leverage his interests in digital signal processing, communications systems engineering, and CMOS integrated circuit design for high-speed data transmission systems. The company, even today, takes pride in its proprietary DSP hardware architectures, system-on-a-chip design methodologies, high-performance CMOS designs for RF, analog and mixed circuits and its custom microprocessor architectures.

The company’s strengths are especially interesting in the context of its much touted entry into the mobile space. While these strengths are imperative to the company’s success in this space, they also highlight an important weakness - the de-stressing of the theoretical underpinnings in their design and development process. Mobile wireless communications is severely constrained by power and also faces interference issues. Besides, there is and will continue to be competition for spectrum, and receiver algorithms need to be designed with that in mind. It is therefore important to understand the theory behind the system design. An ideal company needs a balance between the theoretical notions and the system design.

Broadcom has definitely sought to address this traditional weakness by roping in bright information theoreticians. Chief among them is the VP and CTO of the mobile and Wireless group, Dr. Nambi Seshadri. I have great respect for Dr. Seshadri, who in 1999 was the co-recipient of the Best Paper Award from the IEEE Information Theory Society (essentially the highest recognition accorded to information theoreticians around the world).

So, like most semiconductor companies, Broadcom’s traditional strengths are in circuit design. It perceives mobile communications as an application of its strength. With its relatively late entry into the mobile space, BRCM’s long-term interests will hinge on its successful trial and delivery on the chip announcements made this year. The success will not only be measured by price and inter-operability but also on relative performance. Therein lies the company’s uphill battle.

In the next few articles in this series, we will look at the company’s growth and businesses and how they fit into its future plans.