California-based chip maker Broadcom (Nasdaq: BRCM ) has a successful hold on most segments of the burgeoning wireless communications market. But it's lacking in one crucial area -- and in order to catch up with the competition, the company will have to go toe-to-toe with an industry giant.
In the 1980s, high technology -- and high growth for investors -- meant computers, plain and simple. Apple (Nasdaq: AAPL ) , Microsoft (Nasdaq: MSFT ) , and Intel (Nasdaq: INTC ) were the giants of the time. Investors were piling into high-growth stocks of companies building hardware and software for the mainframes and personal computers rapidly entering homes and offices.
But today, the PC market is saturated with players, and growth is tempering. Just about every silicon and software developer is looking for new growth. Often, this area of high growth is in communications, particularly wireless. The cellular phone market is the No. 1 bullet on many a corporate list of target markets, thanks to the nearly 800 million wireless phone sales anticipated for 2005.
Broadcom's just one of the companies aspiring to be on top of this new communications era. The company was founded to address virtually every broadband communication service, both wired and wireless. Early in its corporate life, the company excelled at making chips for Ethernet networking, cable modems, and DSL networks, becoming one of the many poster children for the late-'90s Internet boom.
Yet today, the future of the company rests more in wireless broadband communications. The company is off to a great start, with more than 50 million Wi-Fi chips sold. Broadcom also makes the shorter-range Bluetooth chips that are increasingly appearing in cellular phones.
Keep the partygoing
But Broadcom's CEO, Scott McGregor, has ultimately set his sights on the next generation of feature-rich wireless devices. The Wi-Fi and Bluetooth chips that Broadcom currently delivers are low-cost parts that are quickly becoming commodity devices. They generate substantial revenue, but thin profits. However, components for higher-end, third-generation (3G) devices generate higher revenue and margins.
Broadcom's push into more lucrative silicon solutions has gotten investors' attention. The stock has been on a tear, handily besting the Nasdaq (Nasdaq: NDAQ ) with a 40% gain in the previous 52 weeks. The bulk of these gains has come in the last six months, as Broadcom's business has continued to show signs of above-average growth.
The company impressed Wall Street in its most recent earnings report. Quarterly sales soared to $695 million, well above the analysts' average $665 million expectation. Broadcom also posted quarterly net income of $132.7 million thanks to successful new products, particularly its Bluetooth wireless solutions and gigabit Ethernet offerings.
Yet while Broadcom's impressive track record in these competitive markets gives them a good shot at breaking into the market for more advanced cellular components, the company is still a small fish in a big ocean. The company knows it's a latecomer to the market for cellular communication chips, which is currently dominated by Texas Instruments (NYSE: TXN ) and Qualcomm (Nasdaq: QCOM ) . Big challenges lie ahead.
One major hurdle remains
While Broadcom has most of the standards covered in both the wired and wireless technology maps, there's one big void that needs filling. Wideband Code Division Multiple Access, or WCDMA, is the next generation of wireless technology, and it's set to be the dominant cellular standard of the future. Broadcom has no significant presence in this market today, but hopes to come up to speed quickly.
In June of 2004, Broadcom purchased a small San Diego company named Zyray Wireless. Zyray had developed a WCDMA chip that Broadcom intended to integrate into its own suite of wireless offerings. In buying Zyray, Broadcom hoped to integrate the newest WCDMA technologies into its chips for cellular phones.
But Broadcom hit a sticking point. To sell WCDMA components, the company needs a license from Qualcomm, a competing company that holds essential patents in the technology standard. Naturally, Qualcomm demanded a high price for the privilege.
So far, Broadcom and Qualcomm haven't been able to strike a deal. After talks between the two companies broke down earlier this year, Broadcom decided to challenge Qualcomm's royalty demands in court. In May 2005, Broadcom filed a patent infringement suit against Qualcomm, stating that its rival was using Broadcom's intellectual property in some products.
At the same time, Broadcom filed a complaint with the U.S. International Trade Commission (ITC), charging Qualcomm with unfair trade practices. In the following weeks, it also filed complaints in the U.S. District Court, claiming that Qualcomm violates U.S. antitrust laws in the ways it charges for chipsets and patent licenses, controlling the CDMA chip market through discriminatory licensing.
Now, patent infringement suits are almost standard business negotiations in today's IP-heavy industries. But escalating to claims of monopolistic abuse is something else entirely. Qualcomm has long been the target of complaints from many foreign competitors and customers for its licensing terms, which many see as an oppressive tax. But this is the first time another American company has leveled such charges against it.
In the months since the filings, many other companies have come out and filed a complaint with the European Commission in support of Broadcom, calling Qualcomm's licensing practices unfair and discriminatory. These complaints don't really factor into Broadcom's legal dispute with Qualcomm, but all the negative press makes a quick resolution that much more unlikely.
Awaiting a verdict
Much of Broadcom's future success hinges upon the complaints and lawsuits it has filed against Qualcomm. With Broadcom already late to the wireless party, the company can't afford to hold off on product introductions while legal issues are sorted through potentially over several years. If the company cannot ship WCDMA chips, it may lose business -- or at least opportunities.
However, if Broadcom can somehow avoid a protracted legal battle and cut a favorable deal with Qualcomm, the company has a chance to make inroads to a sizeable market.
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Fool contributorDave Mockcut his teeth in the computer age and has a soft spot for teletypes, punch cards and Pong. He owns shares of Intel and Qualcomm, and is the author of its first corporate biography --The Qualcomm Equation. Microsoft is aMotley Fool Inside Valuepick. The Fool has a disclosure policy.