Qualcomm Inc (QCOM)

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WiMax: The Morning After

August 9, 2006, 12:26 pm
Posted by Tiernan Ray

http://blogs.barrons.com/techtraderdaily/2006/08/09/wimax-the-morning-after/

Lots of pondering regarding yesterday’s announcement by Sprint (S) that they will spend $3 billion to build what the company is calling the “fourth generation” of fast cellphone technology.

Prudential Equity Group’s Inder Singh is skeptical. He says that because the WiMax technology being developed by Intel (INTC), Motorola (MOT) and Samsung Electronics differ from one to the other, there may be substantial obstacles to WiMax gaining momentum in the next couple years despite Sprint’s confidence in the stuff. (That’s a picture at left of one of Motorola’s “Canopy” access points, which is the umbrella brand for its non-cellular wireless equipment.)

In addition, Singh is already raising a red flag for Qualcomm (QCOM), which has been selling equipment for fast wireless service called “CDMA” and could see those sales displaced by WiMax:

In the event that 802.16e becomes a longer-term de-facto standard, then there could be some downside risk to CDMA beyond 2008/2009. While Sprint has accelerated its plans to start rolling out EVDO Rev A in 4Q06, we feel that plans for an EVDO Rev B upgrade, expected later in the decade, have become uncertain.

Piper Jaffray wireless analyst Michael Walkley is holding the line on Qualcomm, though. Walkley rates Qualcomm Outperform and thinks the stock could hit $57 in the next 12 months. He thinks Qualcomm’s intellectual property claims will prevail in a battle with Moto and the rest over WiMax:

Yesterday, one of the larger CDMA carriers, Sprint, announced ahead of the U.S. spectrum auctions that it planned to build a mobile WiMAX network, and it expects to spend $1B in 2007 and $1.5-$2.0B in 2008. While we view this decision as a slight negative to QUALCOMM based on the technology choice versus Flarion acquired technology, we believe QUALCOMM could still assert its patents and potentially collect royalties. Longer-term, we believe Sprint may offer CDMA/WiMAX products that QUALCOMM would still collect royalties.

UBS’s wireless analyst Maynard Um thinks Sprint’s move is basically a fluke, for now:

We view Sprint Nextel’s decision to launch WiMAX as unique given its spectrum position and not necessarily an indicator of a broader industry trend by wireless operators to move to WiMAX. We believe WiMAX has some hurdles to overcome and expect most wireless operators will maintain current paths to [Wideband CDMA, backed by Nokia (NOK)] or [Evolution-Data Optimized, or EVDO, and EVDO Rev.A, Qualcomm’s follow-on versions of of CDMA].

Sprint had to use the spectrum or lose it, in Um’s view, and Qualcomm should do just fine:

We believe QCOM’s Flarion acq was more strategic for IP rather than infrastructure wins and we still expect the wireless industry to generally move toward 3G technologies (WCDMA
or CDMA) first.

The more important thing, from Um’s point of view, is that Motorola is back in business with Sprint, where its relationship as a vendor had lagged:

While Motorola has had a strong relationship with Nextel, the company’s position at Sprint was lacking despite efforts to make in-roads. We believe this WiMAX announcement as well as the announcement that CDMA versions of SLVR and Q phones will ship to Sprint in 4Q06 is evidence that Motorola’s focus on “customer delight” is bearing fruit. We believe Motorola’s renewed relationship with Sprint Nextel could potentially open up revenue opportunities beyond Mobile Devices and Networks to Connected Homes.

And what does it all mean for Sprint? While that $3 billion might seem like a heart-stopping outlay, Credit Suisse analyst Christopher Larsen says the threat to operating profits won’t be as bad as you think, and he seems to really believe Sprint’s claims that it will save money with WiMax:

As discussed on its 2Q06 conf. call, the deployment could dilute EBITDA by less than 5% in ‘08, depending on the success of various products (new revenue streams). We think the network has the potential to completely offset or limit this dilution to low single digits. Potential revenue and EBITDA impacts should be included in ‘07 and 3-year guidance given late ‘06 or early ‘07. […] Sprint should realize savings, as the subsidies to embed a 4G chipset into devices are cheaper than that of EVDO/EVDO RevA. Service should be available in the first few markets in 4Q07 with throughput speeds of 2 - 4 Mbps. Mgmt indicated that there will be products that can interact with both WiMax and EVDO RevA.

But wait a minute: Jeffrey Halpern with Sanford Bernstein in New York has some harsh words for Sprint, which announced horrendous second quarter financial results last week. Halpern says the $3 billion expense is pretty much figured into the stock price, and that Sprint could still be a “value,” but he’s putting the company into the penalty box. After issuing a 30-page note yesterday, Halpern felt moved to highlight all his concerns in two more notes this morning, the substance of which are:

Announcing a next-generation network and highlighting its potential to benefit the company in 2008 and beyond at a time when investors have borne the weight of Sprint’s operational mis-steps for the past three quarters and are questioning management’s ability to navigate its core business in 2006 and 2007 called into question for us and a few of our clients the soundness of management’s priorities. The key difficulty in assessing yesterday’s announcement is that it is simply too early to tell if the planned 4G services for Sprint will prove the equivalent of the company’s $3B failed Project ION or wildly successful Nextel Direct Connect service.

And so…

To that end, in our modeling we give Sprint no credit for incremental revenues or profits from 4G given: (1) the early stage of the project, (2) Sprint’s poor recent performance growing revenue per subscriber on its existing networks, (3) the almost unavoidably low industry batting average when “developing a new market that doesn’t exist today” (Gary Forsee’s words, not ours), and (4) Sprint’s prior experience with Project ION.

But still, he recommends the stock:

We rate Sprint Outperform given the intrinsic value we see in the company. Our target price of $21 already assumes long-term ARPU degradation to average industry levels, continuous modest improvements in both postpaid and prepaid churn (potentially an optimistic assumption), investment in 4G wireless leveraging the company’s 2.5 Ghz spectrum (but no potential upside from that investment), and ongoing core network upgrades.

They write ‘em, I just report ‘em.

Sprint shares are shrugging off any such worries, up 2.41% at $17.03, as have Qualcomm shares, up 2.33% at $34.65. Motorola shares are up 1.8% at $23.22.

Addendum: My apologies for missing a thoughtful note on Moto’s involvement penned this morning by Ittai Kidron, who follows Motorola for CIBC World Markets. When I talked to Kidron in back in March for a story on WiMax, he was fairly skeptical that the technology could ever be a really big market for equipment vendors. Kidron’s expectations for WiMax are still conservative, but he thinks Moto’s involvement in the Sprint project, plus its acquisition of wireless investor Craig McCaw’s WiMax startup, NextNet, bodes well for Motorola’s bottom line — and for the company’s intellectual property position vis-a-vis Qualcomm:

We highlight that Motorola is also making an aggressive move to lock in as much of the IPR in this emerging area, which we believe is important given that Qualcomm’s IPR intentions related to WiMAX have yet to be revealed. We believe Motorola’s strong stance (coming from both internal development and acquisitions, such as its recent acquisition of NextNet) is meant to be an early effort to neutralize Qualcomm’s IPR position.

As a consequence,

We are not adjusting our estimates at this time, but given growing share and no credible competition from the large wireless infrastructure equipment suppliers in mobile WiMAX, we believe there could be sizable upside to our broadband projections. Our current estimates for Motorola’s broadband networking sales include about $200-$250 million in broadband wireless revenue in 2006 and a doubling of that figure in 2007 to more than $500 million in annual revenue.

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