Qualcomm vs. Nokia

According to the Nokia (NYSE: NOK) website, third-generation (3G) wireless includes three standards: WCDMA-DS, MC-CDMA, and UTRA TDD. No matter what these letters stand for, it is obvious from a glance that CDMA (Code Division Multiple Access) is essential to 3G. To emphasize the point, UTRA TDD is also referred to as TD-SCDMA. Hmmm. Notice a pattern here?

The prince that was once CDMA will soon become a king. TMF Mycroft challenged this position in his recent Rule Maker article. He contends that 3G is a long way off, and investors should pay more attention to the 2G and 2.5G markets. Maybe so, but as the acronym soup in the opening paragraph established, CDMA will be essential to 3G whenever it arrives. According to the International Telecommunications Union (ITU), that will be 2001.

In the wireless world, Qualcomm (Nasdaq: QCOM) and CDMA are practically synonymous. Nokia and handsets share a similar connotation (sorry, Motorola (NYSE: MOT)). Why don't these industry behemoths just get together like Microsoft (Nasdaq: MSFT) and Intel (Nasdaq: INTC) did in the 1980s, and divide up the industry rather than carrying on like a couple of kindergartners in a playground spat? What's with the lawsuits and negative sentiment? Why can't we all just get along?

Simple. Because when a computer using an Intel chip pre-loaded with Microsoft Windows is sold, Intel does not have to fork over part of its profit to Microsoft. Dr. Irwin Jacobs, Qualcomm's Chairman and CEO, has concocted just such a scenario. He wants a cut from every CDMA product sold. Every handset. Every base station. Every commercially viable CDMA mobile system. Nokia is still looking for its checkbook.

How did this whole mess get started? After all, Nokia has been involved with CDMA for years. Many think Nokia is anti-CDMA. Not true. Nokia has a long history with CDMA, dating back to 1991 when it established an office in San Diego (home to Qualcomm). It has always been a member of the CDMA Development Group (CDG) and even helped improve CDMA over the years. It released the first dual-mode and tri-mode/dual-band CDMA phones. In fact, Nokia is a licensee of Qualcomm's CDMA rights.

The trouble started with CDMA itself. CDMA's technological advantage over other standards like GSM and TDMA threatened to upset the wireless industry. CDMA was developed with the best technology in mind, not the most accommodating technology. In other words, CDMA development was not tainted by the political and territorial issues that influenced GSM and TDMA. CDMA is a pure breed, and GSM and TDMA are mutts. Therein lies the problem.

Qualcomm has surrounded CDMA with so many patents that even speaking those four letters in public merits a royalty payment. Nokia builds the most phones (81 million in 1999 for 31% of the global market) and does not want to pay Qualcomm a percentage of its cut for each one sold. Let me rephrase that. Nokia does not want to be Qualcomm's whipping boy.

For the past few years, wireless industry titans such as NTT DoCoMo (Nasdaq: NTDMY) and Nokia have challenged the validity of Qualcomm's CDMA patents around the world and have lost. Courts such as the European Patent Office (EPO) and the Japanese Patent Office (JPO) have ruled in Qualcomm's favor time and time again, with each ruling representing a notch on Jacob's bedpost and a motivational kick in the gluteus maximus to Nokia and gang.

Enter W-CDMA. Wideband CDMA was created for several reasons and one of them was not necessity. Politics? Yes. Ego? Yes. Independence? Yes. Need? No. CDMA offers the commonality, compatibility, quality, global usability, and multimedia capability desired by the ITU in establishing a 3G standard. Sure, W-CDMA offers a link between GSM and 3G, but it also gives competitors a way around Qualcomm and, therefore, loosens Qualcomm's grip on the future of wireless technology.

W-CDMA offers a technological progression from current 2G GSM networks to 3G W-CDMA networks. As it stands today, GSM (Global Standard for Mobile Communications) is the digital wireless leader, with nearly 70% of the global market, according to the EMC World Cellular Database. Almost all of Europe and most of Asia Pacific use GSM. CDMA threatens to unseat GSM as the global standard as we approach 3G reality. If this happens, it means billions in infrastructure spending to replace the existing GSM networks in Europe and Asia Pacific, not to mention AT&T's (NYSE: T) TDMA network here in the States. W-CDMA was developed with this in mind.

W-CDMA also provides royalties to Nokia and Motorola, which both hold GSM intellectual property rights (IPR) necessary for W-CDMA. These IPRs are more than revenue streams; they are bargaining chips used when negotiating cross-licensing agreements.

Cross-licensing agreements are common practice with technology companies, and are often win-win scenarios. Both parties give up rights to proprietary technologies or processes for access to rival technologies or processes that enhance their own product, and neither company shrinks its margins in the process. Smiles all around.

By spinning off Qualcomm's chipmaker division (referred to as Spinco), Dr. Jacobs hopes to preserve his profitable CDMA royalties in one company, while creating a competitive global chipset maker with the other.

Let's assume for a moment that Qualcomm was not planning the spin-off of Spinco.

Qualcomm, through Spinco, is the leading global producer of MC-CDMA chipsets. Because W-CDMA has been accepted by the ITU as an alternative 3G standard, Qualcomm must be able to produce W-CDMA chipsets to remain competitive. Industry practice is to sign a cross-licensing agreement allowing both parties to use each other's technology, sans royalties. Qualcomm must trade away its lucrative CDMA IPRs to get the W-CDMA IPRs it does not own. Bye-bye patent prize.

Without Spinco, Qualcomm retains its prized CDMA IPRs, and Nokia and the other handset makers still have to pay royalties. Spinco gets a few CDMA patents to make chipsets, but not enough to allow cross-licensing agreements that threaten Qualcomm's IPR royalties. No wonder Nokia is still putting up a fight.

Qualcomm has a bright future in wireless, but because of W-CDMA and an industry backlash against Qualcomm's stranglehold on CDMA, its position isn't as unassailable today as it was a year ago.