A Key to Making Money in Wireless Investments
Revised December, 2004

Understanding Intellectual Property

"Want to make a fortune, kid? Build a better mousetrap!" Things have gotten a lot more complex since this old bromide held true in my youth. It used to be that one could make money by inventing a much better product. The customer could see it and feel it. We investors can understand that. We find a neat new product with great potential, discover who makes the product and we invest in the company, just like investment guru Peter Lynch has recommended.

In the last 18 months, consumers around the world have been seeing stunning new cell phones, PDA's that include calling features, and other wireless communications devices. They will see built in cameras, amazing color screens, and "always on" Internet capability. Laptop computers will be connected wirelessly to the Internet. Investors will be enthused with the new products and decide to buy some stock in the device manufacturers: Nokia (NYSE:NOK), Motorola (NYSE:MOT), Ericsson (NASDAQ:ERICY), Siemens (NYSE:SI) or others. That might be a good idea.

Or maybe, invest in companies that supply components to these amazing new devices. Perhaps Texas instruments (NYSE:TXN) or Infineon Technologies' (NYSE:IFX) chip-making prowess is the way to invest. Or the makers of the color screens, the sound system, the antenna or the memory. Some research should lead the investor to the maker of the components inside the cell phone device.

Very few investors will research beyond that. It won't occur to them to go any deeper, or if it does, they will not know how to get at the very heart of that snazzy new wireless communication device. What a shame! That's where investors can make the most money in today's very difficult investing environment. The key is investing in the heart of the product -- what can't be seen by others but which is absolutely essential to the wireless product! It is called "intellectual property." A company that holds the patents on the technology that makes the components work (and therefore makes the device work) is said to own the "intellectual property rights" (g) or the "IPR."

Most investors will assume that Nokia owns the technology that makes its cell phones work. Or looking a little deeper, they will assume that Texas Instruments owns the technology behind the chips inside. They would be partially correct. Nokia will probably own the property rights to 5 percent of the hardware or software inside its new 3G (g) cell phones. Texas Instruments will probably own the intellectual property rights (g) to 10 percent of the technology in its extraordinarily complex new 3G integrated circuits (chips). But who owns the rest of the patented technology which makes the hardware and software work? Who will be paid for it? How well? Motorola shareholders made a fortune leveraging IPR in it in the 1980s. Qualcomm shareholders had money coming out their ears from intellectual property (patents) in the 1990s. Who will be the big winner for the 2000's?

The especially astute investor in wireless communications will dig far deeper than product manufacturers and component suppliers for wireless investing. In the future, the persistent investors who research the firms which own the intellectual property (patented technology) at the heart of the new wireless devices will be recognized as the investment geniuses of the first decade of our new century.

Up until recently, it has been hit our miss for patent holders whose cell phone technology is embedded in wireless devices. Qualcomm was a phenomenonal investment success in the 1990s because of the way it managed its 2G (g) current generation CDMA (g) intellectual property. Motorola learned the IPR game in the 1980s and built a very successful cell phone business because it was a master at leveraging its intellectual property.

Many other firms had a much more difficult time in the 1980s and 1990s collecting royalty and licensing revenue or leveraging their patented cell phone technology. InterDigital Communications Corp. (NASDAQ:IDCC), for example, did not figure out how to do it effectively until the late 1990s.

A much more effective system is in place for determining the holders of intellectual property in the coming 3G (g) devices, and rewarding them appropriately.

The wireless communications industry realized that a much better intellectual property system would be required for 3G. The science and engineering in the new devices would be exceedingly complex, requiring a kind of organized effort of unparalleled magnitude.

The wireless industry believed a "next generation" cell phone with incredible performance (up to 100 times a better than current devices) could theoretically be designed and manufactured. But it would require the insights and efforts of thousands of scientists and engineers from firms throughout the world. Some pieces of the new technology already existed and would be the foundation of the effort. Most would have to be created in such a way that worldwide compatibility would be ensured. Nothing on this scale had been attempted before. The United Nations provided the structure for this worldwide effort through its ITU (g)

Working groups were established with responsibilities for writing specifications (standards (g)) for various aspects of the yet to be developed technology. The result would be extremely complex specifications related to both the wireless devices terminals (like cell phones and PDAs) and the base stations that would tie the devices together worldwide.

These specifications would be known as the 3G international standards. Most of the work on the standards was finalized between 2000 and 2002.

Industry leaders (like Nokia, Samsung, Ericsson, Motorola, Siemens, NEC, Sharp and others) realized that the completed specifications would require intellectual contributions from 100 or more resources. Any given 3G cell phone would incorporate patented technology from 50 or more different firms of all sizes. Some of the intellectual property contributions would be extremely important and others much less so. Some would be "essential" to the operation of the device or base station (it could not work at all without it) and some contributions would be simply "commercially attractive," offering options to enhance various operations but not be essential to its operation. The leading manufacturers were not anxious to pay for the intellectual property contributions of others. But they realized 3G could not exist without the broad input from other manufacturers and from intellectual property "think tanks" who made no products but excelled at providing solutions to the thousands of challenges inherent in the development of the complex new 3G technology.

Under the auspices of the ITU, a very orderly system was established to work through the myriad of technology challenges and simultaneously identify and keep track of the holders of the patents (or patents pending) of the software or hardware suggestions. For an excellent discussion of the standards setting process see the WirelessLedger.com report The Standards-Setting Process. A Key to Making a Profit in Wireless Investments."

So who does own the intellectual property at the heart of the new 3G technology? And how much is it worth?

Much of it is owned by the major cell phone and infrastructure (base station) manufacturers, who will "cross license" their patented technology among themselves with no royalty payments involved in their cross licensing.

Some of it is owned by firms which have only a small amount of patented intellectual property incorporated into the international 3G standards. A strong effort has been underway to work out a licensing program for this technology. Under the program (e.g. 3G3P (g)) a manufacturer would pay perhaps a 5 percent royalty to the organization, which would in turn distribute the royalties in proportion to the importance of the patented technology. A firm whose three ideas, for example, are incorporated into the standards for the antenna might receive 1/20th of this 5 percent royalty. Another firm, with fewer accepted contributions in the standards, might receive 1/100th of the 5 percent royalty pool. Observers estimate that up to 100 different firms will share this hypothetical 5 percent royalty. Among them are likely to be firms such as Prairie Com (U.S.), Parthus (Ireland), TTPCom (U.K.) Ubinetics (U.K.), Condat (Germany) and many others.

A third category, in addition to cross licensing manufacturers and the pool of relatively small contributors, is a potential gold mine for savvy investors. This category represents intellectual property "think tanks" with major contributions already incorporated (preferably as "essential") into the 3G the standards and who are entitled to large cash royalties and license fees. These royalties and fees have already started arriving into company coffers, making their way toward very strong bottom-line earnings for many years to come.

The two IPR "think tanks" that have been most successful in incorporating their patented technology into 3G standards are Qualcomm (Nasdaq: QCOM) and InterDigital Communications Corp. (Nasdaq:IDCC).

Although both firms follow a similar business model, they have unique characteristics which affect their potential as investments.

Qualcomm has the best public relations machine in the industry. Its extraordinarily creative and charismatic leader, Dr. Irwin Jacobs, is a world-class inventor, company leader, lobbyist and spokesperson. Qualcomm has demonstrated an uncanny ability to leverage its patented technology into huge profits over the past decade. The company demands a "bundle license." A licensee is permitted to use any or all of the Company's patented technology for a royalty of 5 percent. That is a huge royalty, considering that the 3G market eventually will be in the trillions of dollars annually. There will no doubt be significant exceptions to the 5 percent royalty. Some observers believe industry leader Nokia will pay Qualcomm around 3 percent. A special arrangement in China will probably yield royalties of 2 percent to 3 percent to Qualcomm. But because the market is so huge, even 2 percent will be a major source of revenue.

The relatively large size of the royalty required, regardless of whether a firm needs a lot or very little of the Company's patented technology, exposes Qualcomm to a certain risk. The manufacturers detest what they consider to be its exorbitant royalties, so they are constantly seeking alternatives to Qualcomm's patented technology. The manufacturers have not found a way around certain older CDMA-related patents and newer improvements on that technology. This well might eventually start drying up, but will be immensely profitable for years to come.

Qualcomm is an IPR "think tank" which has huge overhead costs. It needs this great royalty stream it receives to remain profitable for Qualcomm and is on course to receive it for the remainder of this decade.

InterDigital Communications Corp. is the other IPR "think tank" with substantial patented technology already incorporated into the new 3G standards. In fact, three hundred contributions have already been accepted from InterDigital into the 3G standards. Observers believe that InterDigital has contributed as much patented technology to the standards as any other firm, including industry leaders Qualcomm, Nokia, Ericsson, Motorola, Siemens and NEC.

[InterDigital's CEO says] his company has patented major portions of the "engine and transmission" of the new generation cell phones. Read... "InterDigital" is todays most undervalued wireless company

Considering the size of InterDigital, 1/60th of the market cap of Qualcomm, that is truly an extraordinary accomplishment. InterDigital's overhead is a very small fraction of Qualcomm's overhead level (although some of the overhead is devoted to Qualcomm's chip business.) Savvy investors will note the immense difference in market capitalization between Qualcomm and InterDigital.

But, even if Qualcomm receives 3 percent 3G royalties and InterDigital receives only one half of 1 percent, or 1/6 less than Qualcomm, InterDigital would still be 6 times more profitable, assuming each collected royalties from the same manufacturers. (Qualcomm has been much more successful at that that InterDigital with 2G, but the 3G process is much different, as noted above, considerably enhancing InterDigital's potential ability to collect royalties across the board.)

An earnings wildcard is the finalization of its 2G licensing terms with industry leader Nokia and Samsung, both currently in arbitration. A successful resolution to the arbitration could move InterDigital share prices precipitously higher in the short-term (before the 3G royalty stream arrives in earnest in 2004). Either event has the potential for sparking a rally that could immediately send the InterDigital share price 200 percent or more higher than its November 2004 level of $16.

Astute investors may want to keep both Qualcomm and InterDigital in their portfolios.