Will the new Qualcomm entice investors?

The wireless technology company this week announced plans to spin off its mobile phone chip business, the last in a series of manufacturing and service businesses that Qualcomm has sold or spun off over the past two years.

Despite the intended benefits, the decision creates a convoluted structure--including an executive shuffle--at a time when Qualcomm already has been pounded on Wall Street. The new company will temporarily be named Spinco.

However, the spinoff does allow Qualcomm to gain better access to the intellectual property needed to make future multi-mode cellular phone chips capable of operating on most networks worldwide. The move also is intended to free the San Diego-based company to develop new businesses.

The proposal comes amid evidence that the market for wireless semiconductors may be slowing, which could prove to be good timing for Qualcomm.

"What Qualcomm is left with is patents, basically intellectual property rights," said Dave Berndt, director of wireless mobile technology research at The Yankee Group. "They will have sold off everything they do, except for OmniTracs, their satellite tracking service.

"They're basically going to be a property rights management shop and manage all their patents."

The new Spinco, which will be renamed at a later date, will control the integrated circuit chip business, system software, the high data rate (HDR) wireless Internet access technology, and a location tracking product called SnapTrack--all of which represent nearly half of current revenues, according to executives. Former chief operating officer Richard Sulpizio will become chief executive of the new company.

The original Qualcomm, which still will trade under "QCOM," will continue to own most of the technology patents that generate huge licensing and royalty fees, as well as retain control over other businesses and ventures, including the Eudora email software, the Globalstar satellite phone partnership, and digital cinema deals, which bring the other half of revenues, executives said.

"The revenue for the remaining company will be split about 50-50 between the two divisions, but the licensing division will account for a significantly greater portion of both earnings and growth," Chase Hambrecht & Quist analyst Ed Snyder said in a research report.

The spinoff became necessary because of several conflicts that consistently arose, said executive vice president Paul Jacobs, who will be promoted to president of the original company.

For example, Qualcomm's code division multiple access, or CDMA, technology competes with other digital wireless standards. But its chip manufacturing business must begin to develop multi-mode chips capable of operating on a variety of standards, including the competing GSM and TDMA technologies, in addition to analog protocols.

Multi-mode chips will allow consumers to travel worldwide without losing service, including in Europe and parts of Asia that don't support Qualcomm's CDMA. A spinoff will give the chip unit greater freedom to trade intellectual property rights with GSM patent holders who previously balked at swapping with Qualcomm, Jacobs said.

Executives recently promised new multi-mode chips later this year.

In addition, so-called third-generation (3G) wireless technologies are being developed that are capable of delivering high-speed Net access. In terms of royalty fees, Qualcomm stands to benefit from both the emerging CDMA2000 and W-CDMA standards.

But the chip unit's strength in making CDMA2000 chips, as opposed to W-CDMA chips where it is weak, posed problems when Qualcomm pitched carriers on the virtues of CDMA2000, Jacobs said. Some carriers believed Qualcomm was pushing CDMA2000 so it also could get a piece of the chip business, he said.

The spinoff will also free the original company, which will retain some engineers and research and development functions, to create new technologies.

"What we're going to do with the licensing revenues is invest in new things," Jacobs said. "It's a virtuous cycle. The revenues go to investments, which create new technologies, which generate more revenues, which go to more investments."

Wall Street approves
Analysts generally applauded the move, with some Wall Street watchers reiterating or upgrading to "buy" ratings. Shares traded higher Tuesday and yesterday before slipping about 4 percent today.

"We continue to believe that the separation of the businesses makes sense for the company and shareholders for several reasons," Salomon Smith Barney analyst Alex Cena said in a research report.

"Foremost, the separation of the two businesses creates separate (chip) and royalty businesses. Thus, licensees won't have to pay the same company for royalties as well as for chip purchases, which has created conflict in the past among licensees," Cena said.

"Second, Spinco will have more effective access--through its ability to cross-license--to third-party technologies such as GSM to enter the multi-mode chip business. Third, both companies get greater strategic focus."

Chase H&Q's Snyder, who upgraded Qualcomm to a "buy" this week, said he believes the move was a smart way to protect the company's CDMA patents and related royalties, while recognizing that it needed to develop multi-mode chips in the future.

But the spinoff is complex, somewhat unexpected, and could serve to confuse casual investors--many of whom helped drive the stock to sky-high levels last year. The move also comes when the company already has seen its shares slip on Wall Street amid concerns about the future of Qualcomm's technology in China and Korea.

One of the largest gainers on Wall Street in 1999, Qualcomm shares have been pummeled this year.

Other analysts say the clean split makes Qualcomm a more likely takeover target. The company's depressed stock price sparked such rumors, connecting Qualcomm and Nokia, in June.

"It pares them back so they're definitely an attractive buying target for another company that wants the (patent) rights. And also it puts them in position to start building new technologies, perhaps, and moving forward," Berndt said. "But they really don't have much left."

Good time for an exit?
The proposed spinoff is not without precedent. Qualcomm previously rid itself of several other manufacturing and service businesses.

When the company first developed its CDMA technology roughly a decade ago, Qualcomm needed to make the parts and phones, build the systems, and provide CDMA-based service to help the new technology grow.

But now that CDMA has begun to flourish and is supported by many of the world's largest carriers and equipment makers, Qualcomm doesn't need to make the products to ensure its technology's success.

Qualcomm may have picked a good time to exit the chip business.

A recent report from the Strategis Group, a market researcher, projected that the worldwide wireless subscriber growth is expected to "slow significantly through 2007, especially in mature markets."

The Strategis study showed that although the wireless industry will grow slower than it did between 1993 and 1999, the market will increase to 1.37 billion users worldwide by 2007, up from 530 million today.

Similarly, Nokia today warned that third-quarter sales are likely to slow, sending stock in the Finnish wireless company sharply lower. Ericsson, another major mobile phone maker, recently said semiconductor shortages would affect its phone production.

However, several other companies that supply chips for the cell phone market said at the Robertson Stephens Semiconductor conference in San Francisco this week that overall demand is on track this year.