In honor of The Motley Fool's 10-year anniversary, we're looking back at some of the best columns of the Fool's first decade. In 10 years, the Fool has made its share of bone-headed calls on certain stocks -- but there have been occasional moments of brilliance, too. One of those came on January 4, 2000, when Bill Mann bucked the tide and called Qualcomm's skyrocketing stock price "ridiculous."
This wasn't just a casual remark, but the result of working through the assumptions behind one analyst's infamous $250 price target on the stock -- and finding them to be, well, ridiculous. That day, Qualcomm shares closed at $162, down from its all-time high of $200 the previous day. Needless to say, it's been a steep ride down for Qualcomm since then.
Let's talk about Qualcomm (NASDAQ:QCOM). This is THE story of 1999, particularly at the end, as the share price increased more than 2600% for the year and then nearly 40% in the last week. The final surge came on the heels of a PaineWebber analyst raising his estimate on the company to $1000 per share, or, now that it has split 4:1, $250. I'm not going to make too many friends in the Qualcomm camp here, but this pricing is ridiculous.
Ridiculous because it is impossible? No, not at all -- Qualcomm has a gorilla technology, for sure. But I would call it highly unlikely that the scenario painted in the analyst rating will come to pass. And the current share price is at a level that leaves exactly zero room for error. This in the most competitive industry in the global marketplace, one where companies have proven in the past to be willing to replace existing plant and protocols with better ones if they roll down the pike.
Qualcomm is the owner of Code Division Multiple Access Protocol (CDMA), the most data-friendly wireless protocol in existence. Every company wishing to use CDMA must pay Qualcomm a royalty of 4.5%. Good stuff, that royalty. Qualcomm incurs very low cost of goods sold in receiving royalty payments, perhaps less than 3%. But the PaineWebber analyst's numbers are predicated on three billion phones sold in 2010 at an average price of $180, with a 60x terminal value thereafter. And that is complete bunk. Highly improbable, and most of all, extremely irresponsible. But analysts aren't paid for their responsibility, they're paid to move securities, particularly ones that their companies make a market in, which is the case here with PaineWebber.
Three billion phones sold in 2010. That, if you are counting, is nearly one cellular phone for every two people on the planet. But it's not just that, because they are predicting not the penetration level of phones, but the amount that will be purchased IN THAT YEAR. In 10 years we are supposed to go from the current level, in which India, China, Pakistan and Bangladesh (40% of the world's population) average less than one phone per 40 people to the general population purchasing several phones per family on an annual basis, at an average price of $180?
One of these targets will be missed, I guarantee it. Either the number sold will be low, or more likely, as CDMA devices become more pervasive, the price will drop, just as it has with every other revolutionary technology that has gained general acceptance. So OK, let's just say that three billion CDMA devices (phones and additional data-dependent devices) are sold in 2010. The analyst put a terminal value of 60x 2010 revenues after that, discounting back to today. If we put a 15x terminal value multiple on year 2030 revenues, that equates to a growth rate of 15% per year AFTER 2010, which means that in the year 2030 Qualcomm must sell 49 BILLION CDMA enabled devices, at the current equivalent of $180. If you believe that the company's products will have 100% penetration of the world's population, that will mean the company will have to sell five Qualcomm technology devices per every man, woman, and child on the planet that year.
And all of this is assuming that CDMA will retain its sleeper-hold on the wireless application protocol (WAP) market, an assumption that is reasonable, but not by any stretch of the imagination a given.
I'm running down the rabbit trail a little bit to make a very simple point about Rule Makers: They are companies that control their given markets and have significant potential for future returns. Qualcomm has the first point down but fails miserably on the second with its share price at current levels. It is the true definition of what Burton Malkiel called a "castle in the sky," but one that is based upon a very solid foundation. The thing that disturbs me the most about Qualcomm is that its management has done nothing to keep expectations from getting unreasonable. This doesn't mean cutting the legs out from under its current shareholders, but guiding analysts to reasonable levels of expectations, which is in the management's best interest. Microsoft (NASDAQ:MSFT) has been very good at this, and the end result is that the largest company in the world (by market cap) has never had to deal with irrational expectations for returns.
In the end, this fact discounts Qualcomm for inclusion, as I do not see the potential for fundamental appreciation in the company's share price, only continued speculative surge. What I see is a company that has an extremely aggressive growth target placed on it for the next 30 years and a price that has the majority of that growth already built in. This is not a scenario that a Fool should want to jump into at this stage.
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