Guiding Light

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By BRational
March 8, 2005

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It is always interesting to examine Qualcomm's guidance updates. Thanks to Eric for linking the presentation slides from that event. These are often more informative than guidance provided with the previous quarter's earnings release�even more so now that the company books QTL revenues (handset royalties) only after they are actually paid, as opposed to its previous practice of estimating these revenues based on handset volume estimates. While that made sense when the bulk of revenues came from CDMA 2000, when chipset sales were a good predictor of handset sales a few quarters out, we recognize that, with the growing role of WCDMA, estimates based on past CDMA2000 experience do not transfer readily.

The guidance update numbers provided a nice upside surprise in terms of handsets shipped; contrary to some expectations, wireless handsets are still selling. The lower ASP is not unexpected; the growth in WCDMA, as encouraging as it is, is already facing handset pricing pressures. And ultimately if CDMA 2000 is to grow it would have to ring up higher volumes in the mid to lower tier�impacting ASP's. Still the net effect of lower ASP and higher volumes results in about $20M more added to the bottom line (assuming ~ 5% royalty per handset and the usual 90% conversion factor of QTL revenues into earnings). But we'll know more on April 20 when they provide more detailed geographic breakdown.

These numbers reflect to a large extent the nature of the dilemma in wireless marketing�something that Nokia has been suffering from rather acutely the past couple of years (for Nokia, in spite to unit growth, revenues and earnings are lower year on year, partly due to the dollar-euro effect). While handset makers and carriers all want to push to the high end, high relative volume growth requires greater action on the lower end. All people who can afford them, and many who cannot, already have cell phones (maybe with the exception of some holdouts on this board...); Even as the high end goes on replacing, frequently, high growth rates require an increase of the overall base, which at this stage of the technology diffusion cycle is essentially a lower tier phenomenon. Nokia's results really drive the point home. It has been less of a factor for Qualcomm given the relative affluence and cell phone obsession of its early Asian markets�until China, India and Eastern Europe started gaining more traction. Of course, new technology cycles drive faster obsolescence and faster replacement, and we saw that clearly with 1X, but EV-DO is not quite there. It also remains to be seen if WCDMA will be marketed in Europe more like it is in Japan now (the natural evolution of your next handset), or as a separate higher end service requiring higher-priced handsets (like FOMA was initially, unlike KDDI's 1X which was the only option for replacing 2G CDMA handsets, with the replacement driven by camera phones). It was interesting to note in this regard one of the European operators announcing plans to move half of their current GSM base to 3G within the next year or so�that would produce phenomenal growth rates from Qualcomm's standpoint (not so much for the handset makers because that would be taking the place of GSM replacement handsets, resulting in less dramatic overall growth rates than Qualcomm would see relative to the base of what it currently collects royalties on).

So the relative growth picture for Qualcomm is uniquely rosier than that of most established handset makers with mature market shares in GSM�especially Nokia, because it is already the market share leader in GSM, and is therefore most vulnerable to shifting winds with the new technology. Already we see the Japanese and Korean makers enjoying success in WCDMA with European carriers that they would not have dreamed of previously with plain GSM.

Nevertheless, as the WCDMA agenda was moving ahead, and we were getting concerned about Qualcomm missing the first wave in terms of chipset market share and volume, the company appears to have come back rather nicely by focusing on the next technological milestone, namely HSDPA, and apparently being first to market with reliable HSDPA chipsets. This sector is moving way too rapidly and secretly, and the hype factor appears to be way too high from all kinds of direction to allay the "who was first" debate. The fact is that Qualcomm is now landing design wins with its HSDPA-capable chipsets and the leading handsets with this capability appear to be powered by QCT chips. If this is indeed correct, and Qualcomm's chips deliver on performance and on service with carriers and handset makers, that could mark the kind of turnaround in QCT's WCDMA market share fortunes that shareholders have been hoping for.

This is an interesting time for wireless�as it has been for the past five years, and longer. With the 3G networks now a reality in many places, the hard questions of services and business model are very much on the table. The questions of price points for mobile data services, bundling of services, subscription vs. per use, not to mention diversity of content, will all have a critical impact on where we go from here. What the carriers have delivered to date in this regard does not lead me to have much faith in the unfolding scenarios. As much as I believe in the power of mobility, and untethered access, I sometimes get the feeling that these strides in demand will happen almost in spite of carriers rather than through their well conceived efforts. As I much as I enjoy using my Treo650, to access e-mail on the fly, and read about the latest developments in the market or in the Middle East while politely sitting in meetings, I get a lot more value out of using my EVDO wireless card to connect through my laptop. After almost a year and a half of buying my EVDO card, I am still the only person I know among my colleagues who has one. Many professionals apparently balk at the $80 monthly charge. After years of having GPS location capability on my handset, Sprint has yet to sell me a single service that makes use of it.

These are the kinds of questions on which greater adoption of 3G ultimately depends. Mass marketing calls for hit features; camera phones did that for a while, but they now seem clearly pass�, even as the resolution of the cameras and video makes them even more powerful. I doubt TV on a little screen will sell to the masses�the trend is for home theater, not hand theater. Yet the convenience and excitement story of mobility remains intact. The joys the little toys bring continue to drive replacement, if only to get a higher resolution and clearer screen.

Sometimes it seems that the key business factors and decisions that will determine what we can experience as consumers are too important to be left to the wireless carriers.

Replies and insights are appreciated, as always.


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