A few weeks back, Qualcomm
Let me start by saying that, as a Qualcomm investor, I want it to be buying companies -- or, more specifically, talent, intellectual property and new ideas. I don't want the company spending an inordinate amount of effort milking its patented CDMA technology, which uses the full spectrum available for users, in perpetuity. Qualcomm should be putting its cash to work by scouring the industry for the next "big thing," not to mention all the "little things" that support and augment its current offerings to customers.
Qualcomm has plenty of cash available for the acquisition, so there are not the same risks involved as there would be with a highly leveraged deal. Shareholders will continue to benefit from the company's dividend and share repurchase program that was recently boosted up to $2 billion.
The research and development efforts within the company have already been escalating. Normally, the company devotes somewhere in the neighborhood of 15% of sales to R&D. Qualcomm has been kicking this expense up toward 20% in the last few quarters.
So going forward, I'd rather see the company putting some of its cash hoard to work outside existing operations, as opposed to increased dividends or share buybacks, or even more R&D. (Or solid gold toilet seats for the employee bathrooms, for that matter.)
OK, so it's easy enough to make a pro argument for Qualcomm selectively acquiring good companies, but was Flarion a worthwhile buy? Especially at $600 million?
Invaluable or un-valuable?
Despite some of the positives that I mentioned above, I've received quite a few emails from investors who are dubious of the purchase, particularly the price paid for a small company that generates little revenue. Some have even performed a quantitative analysis of the deal, estimating the value of the patents that Flarion holds, or the number of royalty-bearing licenses Qualcomm will need to land to recoup its acquisition costs.
In my opinion, there's no way to do a reliable quantitative analysis on the value of Flarion as part of Qualcomm at this time. Lick your finger and stick it in the wind -- you may get a better answer. While Flarion has commercial equipment fielded with its proprietary technology, the real value of the company is something that we won't see realized for several years. I realize this sounds like a convenient excuse that gets me out of backing up arguments with charts and numbers -- guesses disguised as hard data, really. But if finding great investments was all numbers and no insight, all we'd need are fancy calculators to become fabulously wealthy.
Qualcomm's history of success centers on placing big bets on significant opportunities that take years to develop. Qualcomm sunk hundreds of millions of dollars into its CDMA technology push for more than seven years before seeing the windfall return. The acquisition of Flarion and its technology is in this same vein.
I talked about this style of long-term development -- what I call seeding markets -- at length in The Qualcomm Equation. In 1994, the company committed millions to build a wireless infrastructure product division in a joint venture with Nortel. That same year, Qualcomm paired with Sony and invested in a division to build cellular phones. Both business lines sucked millions of dollars out of the company, had it bleeding cash, and kept its stock in the slow lane for years. But these efforts were a means to an end.
These investments returned value to the company indirectly, in more subtle and immeasurable ways. When taken all together, Qualcomm's heavy spending enabled its CDMA technology to dominate many cellular markets. The royalties generated each year from this alone have more than paid for the sunk cost for all the investments.
Building the dream team
There are several competitive aspects that could make the Flarion purchase pay back in spades. The first is the offensive tack that Qualcomm has insinuated it may follow -- to pursue royalties on products made with OFDM (orthogonal frequency division multiplexing) technology, a technique for sending large amounts of information over a radio wave. This is Flarion's specialty, and it has substantial intellectual property and patents in this area. This would pit Qualcomm against mighty Intel
I think this strategy is a long shot, however. Qualcomm did succeed with CDMA, and OFDM is positioned today much like CDMA was around 1993. But even Flarion's ownership of OFDM patents doesn't give Qualcomm the same lead it had in CDMA back then. There are dozens of other companies that have competence and essential patents in various methods of OFDM, which wasn't the case with CDMA in its early days.
With Qualcomm's resources, it may be more effective at leveraging Flarion's proprietary version of OFDM, called Flash-OFDM, to get an early lead in the mobile broadband market. Flash-OFDM is commercially released and works today, while most other solutions remain on the drawing board. Whether or not Qualcomm ends up earning royalties on WiMax products, it is likely to develop into a serious proprietary contender.
Building a diverse moat
I think most of the benefits Qualcomm will derive from the Flarion deal are defensive in nature. One of the classic strategic advantages investors look for in companies is a technological or strategic moat that keeps competition out. In Qualcomm's case, it places great importance in protecting its royalty stream. If Qualcomm was only about CDMA, that royalty stream would eventually evaporate as the technology matured. Notice that Qualcomm's press releases no longer refer to the company only as a CDMA pioneer. It's now promoting itself as a developer of a diverse set of advanced wireless technologies.
Invaluable expertise and essential patents in the coming generations of several different wireless technologies can allow the company to keep its lucrative licenses going longer. With Flarion on board, Qualcomm can charge and maintain royalties on a broader range of wireless technologies. If the Flarion purchase helps Qualcomm extend licenses even one year longer than they would have otherwise, the purchase price was well worth it.
Taken all together, Qualcomm is far better with Flarion as a component than as a competitor. Owning the technology and talent behind Flarion will help the company keep an invaluable edge against any companies hoping to marginalize Qualcomm's dominant position in the future.
We've queued up further Foolishness:
- Who needs enemies when you have friends like this?
- Qualcomm gets up close and personal.
- After two decades, it's time to do a little shuffle.
Fool contributor Dave Mock can rub his tummy, pat his head, and chew gum at the same time. He owns shares of Intel and Qualcomm, and is author of The Qualcomm Equation. The Fool has a disclosure policy.