"The largest profits in business accrue to the company
that supplies the key missing element that completes a commercial system and
ignites a new spiral of advance."
Peter Drucker.
QUALCOMM’s (QCOM 40) stock price will be driven by the commercial success of 3G (third generation) CDMA networks. 3G networks promise better profitability to operators like Verizon and Sprint PCS, while offering new capabilities to wireless device users, such as gorgeous color displays and data services.
There are two “flavors” of 3G CDMA. CDMA2000 is pure Qualcomm, while WCDMA is Qualcomm’s adopted orphan. Certain other companies originally concocted WCDMA in an unsuccessful effort to skirt Qualcomm’s patents, and now Qualcomm is fixing it. Both pay royalties, but Qualcomm is the sole source of working chipsets for CDMA2000. Therefore, CDMA2000 should be more profitable for Qualcomm. With that background, it is interesting to compare the commercial success of the two different 3G CDMA flavors.
The world's first
3G networks are already providing service to millions of paying subscribers. By
the end of March 2002, there were 7.35 million CDMA2000 subscribers in Korea
and an estimated 89,400 users of the FOMA (WCDMA) service offered by NTT DoCoMo
in Japan.
There are many new CDMA2000 launches. In Korea, SK Telecom and KT Freetel have launched commercial operation of CDMA2000-1X EV-DO in time for the World Cup Soccer Championship. “DO” is the “data optimized” version of CDMA2000 that operates at broadband data rates up to 2.4 mbps (mega bits per second), equivalent to the maximum measured speed of my Cox Communications broadband cable Internet connection.
While NTT’s WCDMA requires multi-billion dollar spending to build brand new networks for 3G services, CDMA2000 involves lower costs to boost transmission speeds, because existing networks only need to be upgraded. Also, thanks to “backwards compatibility,” KDDI’s users need only one handset, while DoCoMo 3G users have to carry two handsets if they want to be connected everywhere in Japan. The CDMA system also features GPS (global positioning system), a service WCDMA networks will not be able to offer. KDDI will soon start building out its CDMA-1X EV-DO 2.4 mpbs wireless Internet connection.
Other CDMA2000 launches include Zapp Mobil in Romania on December 7, 2001, Bell Mobility in Canada on February 12, 2002, Centennial Wireless in Puerto Rico on April 4, 2002, Telesp Celular in Brazil on December 12, 2001, Telefonica Celular in Brazil on April 16, 2002, and Leap Wireless in the US on December 10, 2001.
There are no commercial WCDMA launches other than NTT DoCoMo’s to report at this time.
Monsanto (MON 33) is the leading global provider of technology-based agricultural products to farmers. The company’s business model integrates Roundup herbicide with seeds and biotechnology traits to offer total solutions to the farmer. Roundup dominates the selective herbicides market and provides the cash flow needed to make Monsanto the world leader in biotechnology crops. Seeds with Monsanto traits accounted for more than 90 percent of the acres planted worldwide with herbicide-tolerant or insect-resistant traits in 2001. Monsanto has received over half of all US Department of Agriculture approvals for biotech products.
Synergy is created between Roundup and the seeds by offering Roundup Ready seeds for soybeans, canola, cotton, and corn. Roundup Ready seeds enable “conservation tillage”, in which a farmer plants without tilling. This benefits the soil by preventing erosion and retaining moisture. It saves farmers time and money, in particular allowing some third world farmers with less machinery to plant an extra crop in a year.
Insect resistant seeds permit higher crop yields while preventing the usage of vast quantities of insecticides that eventually end up in the world’s oceans. Monsanto has developed corn, soybean, and cotton seeds that resist their most damaging pests. It has become uneconomic for a farmer to plant a non-resistant cotton crop. Soybeans engineered to provide higher levels of protein and Omega lll oils increase value to both the farmer and his customer.
The company has just completed a multi-year capital expenditure program that greatly expanded Roundup production capacity and established its worldwide seed distribution network. The absence of this spending will result in a doubling of free cash flow this year, and an additional 20% increase next year. In dollar terms, that indicates growth in free cash flow from $183 million in 2001 to about $500 million in 2003. Free cash flow is one of the most fundamental metrics used to value businesses.
Operating earnings will not grow as fast, as these expenditures now have to be amortized and depreciated. Management projects operating earnings per share to grow in the single-digit percentages in 2002 and 2003, to about $2.25 and $2.40, respectively. Operating earnings growth thereafter is likely to increase somewhat. Five new seed traits pending approval could ultimately add $1 billion to revenues and $1.70 to earnings per share, reflecting the 60% - 80% pharmaceutical-like profit margins on biotech traits. Specifically, these traits are Roundup Ready Soybeans in Brazil, Yieldgard Rootworm Corn in the US, Bollgard Cotton in India, Bollgard Cotton ll in the US, and Roundup Ready Corn in Europe.
Monsanto is 85% owned by Pharmacia. This stock will be distributed as a tax-free dividend to Pharmacia shareholders late this year. There is a presumption that since Monsanto is not considered a pharmaceutical company, many of the Pharmacia shareholders will sell their Monsanto distribution. That has placed a realistic but temporary ceiling on the price of Monsanto. Offsetting that potential selling pressure is the enormous free cash flow that could be invested in repurchases of stock. Intrinsic value calculated by discounting back the future economic profit stream is estimated to be above the current stock price. With $4.00 earnings a reasonable possibility in five years, the stock looks cheap.
Church & Dwight (CHD 31) is the owner of a great group of brand names, starting with Arm & Hammer Baking Soda. Management has extended that highly recognized and trusted brand name into laundry detergent, cat litter, toothpaste, deodorant, and bathroom cleaners. Including all of their products, CHD competes in 11 categories and is #1 or #2 in 8 of them. I met the CEO, Bob Davies, about five years ago at a consumer brand names conference and remember being impressed by this man’s steady and sure plodding approach to building a business. Note that he has nurtured earnings growth in the high teens and revenue growth near 10% compounded over his seven years at the helm. This is the type of plodding I like. However, the stock was not cheap the first time I looked at it. The Proctor & Gamble implosion of early 2000 was needed to provide the half-price clearance sale I was looking for.
Church & Dwight, proud of its R&D abilities, has maintained a steady flow of new products. Ultramax, an important new deodorant, is in the early stages of introduction right now. The company claims it not only absorbs odors, it eliminates them, making it effective for 36 hours. This will certainly be a top-of-market deodorant, and it will be interesting to see how the consumer reacts.
The growth has kept on coming at CHD, and the most exciting, and frankly, most risky, times lie right ahead. Church & Dwight made two very large purchases last year, which have the potential of providing ten positive or ten negative points in the stock. USA Detergents was acquired early last year in order to give more competitive mass to the combined companies. The integration and consolidation of the two laundry detergent businesses is going extremely well under the careful hand of Bob Davies.
The second acquisition is the consumer brands of Carter Wallace, which includes Arrid deodorant, Nair depilatory, First Response pregnancy test kits, and Trojan condoms. This gives CHD a lot of new revenues and a couple new categories in which they have a commanding market share. Here is the risk: this is by far the largest acquisition Church and Dwight has ever made. Despite an excellent track record of consolidating numerous past acquisitions, they have to get this one put to bed well. I am trusting in management’s track record, and in the price paid for the acquisition. Basically, it was so cheap that certain famous shareholders of Carter Wallace sued to block the transaction. They lost, and CHD bought time-tested products at a great price.
The success of the merger has a very large impact on my estimation of the intrinsic value of Church & Dwight, increasing it from the high 20’s to the high 30’s. It accelerates earnings per share growth from 12% to 18%. This next year will be very exciting.
Steven L. Ré, CFA April 17, 2002
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not to be construed as a recommendation to purchase or sell securities. The above information is from sources deemed
reliable but is not guaranteed. It
should not be assumed that investments in any of the above-mentioned securities
will be profitable, and past performance is not a guarantee of future
results. Earnings projections often
miss, and markets don’t always go up.
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