Three and a half years ago, I inadvertently called the absolute high on Qualcomm (NASDAQ:QCOM). The stock, you see, peaked early in January 2000, a few months before the Nasdaq started its own death march. At the time, we were looking at telecommunications Rule Makers, and I raved about Qualcomm's potential but called its valuation "ridiculous."
That was January 4. A day earlier (the day I actually wrote the column), Qualcomm briefly touched $200 per share. This was on the heels of an extraordinary 1999 that made the stock a 28-bagger in a single year, and a few weeks after a Paine Webber analyst named Walter Piecyk put out a $1,000 price target ($250 after splits).
Needless to say, among the Qualcomm faithful my opinion was sacrilege. Qualcomm had, after all, made thousands filthy rich in no time. And there was something intrinsically great about the company and its business that made people so excited.
Moon River at 99-to-1 in the 5th at Aqueduct this wasn't. This was a dominant player with an ironclad, patent-protected grip on a universal technology application. With Qualcomm, unlike most of the dot-com atrocities, there was a there there.
Fast-forward to today
At one-fifth the price, Qualcomm is still valued at a hefty $29 billion, though $4.3 billion in net cash makes it somewhat cheaper than it appears. Last year's revenues, profits, and free cash flow -- after a swoon in 2001 -- are remarkably similar to what they were in 2000. At $3 billion in revenues, Qualcomm is a major success; it just isn't what was predicted in 1999. It couldn't be -- the price of the stock had discounted everyone on the planet using Qualcomm technology.
In November 2000, Todd Lebor looked at Qualcomm once again, when it was "more reasonable" at a P/E of about 50. I disagreed with this characterization, since the stock had simply dropped from insane to absurd, and I also thought Todd's conclusion -- that Qualcomm was no Rule Maker -- was wrong.
Heck, yeah, it's a Rule Maker. Qualcomm and Nokia (NYSE:NOK) are the two totally dominant telecommunications companies of any flavor. That they both happen to be wireless companies and occasionally deeply at odds with one another is no coincidence. Qualcomm's technology is still the friendliest for high-speed wireless connectivity (just as 3G was the late 1990s' Holy Grail with broad high-speed cellular networks, it is now Wi-Fi). And CDMA still offers advantages over its peers.
So, let's run through the old Rule Maker criteria, eh?
The company must have at least one sustainable competitive advantage. The more, the better.
What shelters Qualcomm from its competition? Eight hundred different patents (of varying values), to start with. A technology that provides carriers a route to substantially lower operating expenditures for wireless networks, for another.
The company must be dominant in its industry. No company in the wireless industry wields Qualcomm's influence, with the possible exception of Nokia. It's the elephant in the room. Companies have spent years of R&D and millions of dollars trying to circumvent Qualcomm's patents and, thus, royalty payments. They have yet to succeed.
A Rule Maker has been dominant for more than a decade. Not really. We're dealing with a wireless industry that is no more than 15 years old. Maybe it was a "pursuit" before that, perhaps a "concept." High-speed wireless is substantially even younger. The answer here is no. But Qualcomm is a Johnny-come-lately in a field of Johnny-come-latelies, so no big deal.
Cash King Margin in excess of 10%. God bless those intellectual property (IP) companies. Qualcomm's Cash King Margin exceeded 27% in 2002, meaning that for every dollar of revenues it pulled in, it generated more than $0.27 in free cash flow. For the most recent quarter, that number was 50%. Astounding.
Efficient working-capital management, measured by a Foolish Flow Ratio below 1.25. Uh-oh. Qualcomm comes in at 1.75, with the biggest culprit being its net receivables at nearly four times its net payables. It deals primarily with big companies but needs to get 'em to pay faster.
Sales above $4 billion per year and revenues growing at 10%-plus. Qualcomm will barely cross that first barrier this year. As for the second, after some years of stagnation -- made all the more inscrutable by a revolving door of purchases and (mostly) dispositions of divisions -- Qualcomm's top-line revenues have jumped substantially this year.
Best-of-class management. Irwin Jacobs spent years pounding the table on his CDMA technology, without much success. This all changed in the late 1990s, when a few big carriers saw Europe's run toward GSM and thought that they could do better. Jacobs gets an A+ for determination. Qualcomm, even though it has billions of dollars in the bank, still offers large numbers of stock options -- 3.4% of the company's outstanding shares in 2002 alone.
Return on Invested Capital above 11%. Qualcomm comes in at 8.1% from its most recent quarter. Not great. This will likely improve, as the company recently decided to pay a dividend and then increased it.
Cash no less than 1.5 times debt. Because the company has negligible debt and $4 billion in cash, we're OK here. This reminds me of Cisco's (NASDAQ:CSCO) and Microsoft's (NASDAQ:MSFT) balance sheets -- they're almost too good, insinuating that the company is hoarding cash even though it doesn't necessarily have good use for it. Now that Qualcomm has embarked on a dividend-paying program, this should improve.
A reasonable purchase (or holding) price. Here's where the rubber meets the road. Qualcomm is on pace to generate more than $1.4 billion in free cash flow this year. Given its enterprise value of about $25 billion, that's a multiple to free cash flow of about 17. Essentially, this price discounts a recovery in carrier and ISP spending, which I think is a mistake.
As much as Qualcomm is set to dominate wireless, this is still an industry with years and years of overcapacity left to bleed off. The overenthusiasm from the 1990s still haunts the carriers. Spanish carrier Telefonica (NYSE:TEF) recently wrote down more than $5 billion of its $6.5 billion investment in 3G licenses, while Luxembourg granted 3G licenses for a minimum of $189,000 this month.
The distribution channels for networking, gateway, and other types of equipment are still absolutely stuffed to the gills -- you can still buy brand-new gear on eBay (NASDAQ:EBAY) for pennies on the dollar. The euphoria is over.
But not in these stocks. The most recent jump in stock prices has allowed companies that really ought to be dead to tap the financial markets for additional funding. A glut of cell phone inventory still needs to be cleared. None of this portends additional large deployments of new capital investments in the near future.
I think Qualcomm is a dynamite company. I always have. There are internal issues that bug me, but the biggest challenge facing the company today is it is king of a hill that isn't in very good shape. Could it get better? Absolutely. But I, for one, don't see it happening anytime soon.
Fool on!
Bill Mann, TMFOtter on the Fool Discussion boards.
Still waiting for a rap artist named "CDMA." Bill Mann owns none of the companies mentioned in this article. The Motley Fool is investors writing for investors.
