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This emerging technology is critical for third generation wireless networks
Buy it now before Wall Street figures out what's going on!
by Briton Ryle
Sometimes, the need for an emerging technology is as plain as the nose on your face. And still nobody can see it.
Way back in 1992 and 1993, wireless carriers began the painful transition from first generation analog technology to second generation digital networks. Digital wireless has greater capacity, clarity and efficiency. Now roughly half of wireless subscribers in the United States are on digital networks. By the end of 2000, 70% will have gone digital.
But innovations rarely occur in a vacuum. New technologies and methods always ask new questions and get fresh answers. Iin 1996, an RF (radio frequency) amplifier company thought it had the answer to some of the questions posed by digital wireless. The company believed its multi-carrier, ultra-linear power amplifiers should be an essential part of the new digital networks.
Trying to convince wireless infrastructure companies and wireless carriers was the hard part. Of course, in retrospect, it makes perfect sense. Digital modulation techniques work best with a strong, clean RF signal. But at the time, carriers in the U.S. were just coming around to the idea that cellular services could be a billion dollar, mainstream technology. And they were still skeptical of new and unproved ideas.
The moment of truth
When Powerwave (PWAV:NASDAQ) finally broke through, it wasn't in the United States. In 1997, over 80% of Powerwave's sales were in South Korea, where the first commercial CDMA networks were being built. The company was so tightly linked to South Korea that the now infamous Asian financial crisis took the stock below US$5 for the first time since its IPO. But although the technology had been validated, many still didn't see the investment opportunity.
As digital networks spread, more and more ultra-linear amplifiers were sold in the U.S. and Europe. And a new and unproved technology became an integral part of digital wireless networks. Sales now approach US$400 million a year. Powerwave is the premier name in ultra-linear amplification. And investors who saw the promise in this company have been handsomely rewarded.
Why am I going into such detail about a company I have no intention of covering? Because the Powerwave story sounds eerily reminiscent of one of my favorite companies, Illinois Superconductor (ISCO:OTC BB).
I repeat...
I first began coverage of Illinois Superconductor at the end of January. (And be sure to visit our other site, www.247profits.com for daily commentary.) In just over a month, we watched the stock trounce my 300% estimate as it zoomed more than 700% to US$39 on March 1.
Many of you didn't need to be told to take the huge profits. And I believe this company still represents a huge opportunity in the build-out of next generation wireless networks.
Illinois Superconductor (which may get a name change in the near future) has had its technology validated through selective deployment by several of the largest wireless carriers in this country and by scientists at both Motorola and NTT DoCoMo (remember, these guys have a degree in science). Next up for ISCO — the big rollout of third generation (3G) wireless networks.
Consumers consummate
In Japan, the promise of the mobile Internet has captured consumers' imaginations, not to mention billions of yen. 50 million out of 126 million people have mobile phones. But that's only half the story.
Nearly half of the roughly 24 million Japanese Internet users access the Web through their mobile phones. And three quarters of these are NTT DoCoMo i-Mode users.
Industry estimates say that by 2003, 85% of the Japanese population will have a wireless connection to the Internet. That's over 100 million people. Now imagine a similar situation in the U.S., population 250 million. Or Europe, population 300 million. It'll take a few years, but it's coming.
The popularity of i-Mode has convinced NTT DoCoMo to build the world's first 3G wireless network. Construction might begin as early as spring of 2001. Don't be surprised if the second one's built in South Korea.
DoCoMo's network will be the prototype, the first of its kind. You can bet the entire telecom world will be watching. And I'll bet they'll be scratching their heads.
I love the simple things
I like it when things are simple. And the underlying factors that will drive ISCO's success are as simple as it gets — supply and demand.
We're talking spectrum here. With the prices fetched at recent European 3G spectrum auctions — US$80 billion in the UK and Germany alone — there can be no denying the huge demand for spectrum. Because it's a limited resource.
That's one reason a version of CDMA is the likely standard for 3G service. CDMA (code division multiple access) uses spectrum much like the Internet Protocol (IP) uses bandwidth. Many packets of data (signals in a wireless network) can share the same space because their destination is encoded into the signal.
CDMA is much more efficient than its rival TDMA (time division multiple access) and its more successful relative GSM (global system for mobile communication). TDMA and GSM both divide a frequency into time slots, with only one signal able to occupy a given frequency at a given time. CDMA handles 4 to 5 times the capacity of GSM.
Of course, higher capacity means more subscriber revenues and lower operating costs. When you consider AT&T's average monthly per-user revenues of US$71, an extra 20% amounts to a sizable chunk of change.
In addition to capacity, CDMA can also handle the most data of any wireless technology. 3G networks will bring 2 megs of data to the user. That's enough for streaming video, music, games, whatever your heart desires.
Squeezing the spectrum
Clearly, efficient use of spectrum will be a priority for carriers. And Illinois Superconductor RF filters increase the capacity of CDMA networks by 30%.
That's what the gang over at NTT DoCoMo says. I have no reason to doubt them. They've been testing the filters for over a year now. And it seems they like what they see, as ISCO's filters have been, to (loosely) quote CEO Dr. George Calhoun, "...effectively written into [DoCoMo's] 3G specs."
In case you're curious, I'll try to explain how superconductor filters boost capacity. The RF filters on the receiving end of wireless base stations are designed to let desired frequencies into the system and keep undesired frequencies out. Filters on the transmit side make sure that only the desired signal gets sent out into space.
At any given time, the air around you is full of RF signals. Some may be in the 1900 Mhz frequency range, others in the 800 Mhz range.
Most of these signals have the potential to get picked up by the antenna of a wireless base station. Antennas have no way to distinguish between the signals flying around in the air. That's the filter's job.
The most common filter type is the "bandpass," which lets certain frequency ranges, or bands, pass through while keeping all others out. Conventional filters exhibit what's called "insertion loss."
Insertion loss means that a signal is smaller or weaker when it comes out of the device than it was when it went in. Superconductor filters have virtually zero insertion loss. And that's important because it means the receiving side of the base station can be a lot more sensitive to low power signals. And on the transmit side it means a bigger (stronger) signal can be sent out.
Now, the rest of the news
The big reason ISCO's filters increase capacity has to do with how the available spectrum is divvied up within a coverage area. In general, the available spectrum is broken down into frequency ranges. Adjacent cells (a cell is the coverage area of one base station) will operate in different frequency ranges, though frequencies can be re-used provided there's enough distance between cells.
So one cell may operate between 810 and 820 megahertz, and the one right next to it could be designated 820 to 830. Conventional RF filters aren't 100% precise. It's necessary to leave the edges of the frequency range unused. These are called guard bands, and act as a sort of buffer. What all this means is it's impossible to run each cell at full capacity.
Superconductor filters aren't 100% precise, either. But they're a lot more precise than conventional filters. Superconductor filters can isolate a frequency range down to .5 MHz, which means much less of the available spectrum goes to waste.
A little more technical gobbledygook
Up till now, I haven't spent a lot of time differentiating ISCO from its competitors in the superconductor RF filter space. Here's a quick rundown of what makes ISCO superior. Superconductors depend on refrigeration to perform. ISCO has the only filters that can perform like conventional filters if the refrigeration unit fails. All temperature performance (ATP) eliminates the need for a backup filter system and gives ISCO the smallest total system in the industry.
ISCO's filters are cheaper and easier to manufacture in bulk. The recent acquisition of Spectral Solutions means ISCO has the only viable tower mount feature, is the only company to offer both thick and thin film filters, and will be the first to offer a hybrid of the two. But the bottom line is this — ISCO's thick film filters perform better than thin film filters, as proven by DoCoMo research. So there.
First Japan, then the world
All right, so maybe that wasn't so simple. The point is, superconductor filters dramatically increase the capacity of cellular networks. And Illinois Superconductor is likely to become an integral part of the first 3G network in the world.
ISCO recently opened an office in Japan so it can give its full attention to NTT DoCoMo. I believe there's often an arrogance among American tech companies. They're so used to being technologically superior to the rest of the world that they sometimes don't consider foreign markets as being very important. Judging by the size of DoCoMo's network, that would be a costly mistake, one that ISCO is not about to make.
I've heard estimates that as many as 50,000 to 60,000 base stations will be deployed in Japan. And, even better, superconductor filters are being considered for network-wide deployment.
NTT's multiple vision
NTT DoCoMo will build the first 3G network in Japan. But it wants to be a part of every major market, as it's also developing the wideband version of CDMA (called W-CDMA). Nothing like having your standard be the global one.
As part of its strategy for world domination, DoCoMo took a stake in South Korea's SK Telecom (SKM:NYSE). It was also part of a consortium that won a 3G license in Germany. And it's been trying desperately to gain a foothold in the U.S. market. I think the U.S. 3G auctions deserve a little more attention because there are some really interesting things going on here.
Analysts are concerned that 3G licenses are too expensive. Recent European winners like Deutsche Telecom (DT:NYSE) and France Telecom (FTE:NYSE) saw their credit ratings get downgraded on concerns that they've taken on too much debt. But I've seen estimates that there'll be one billion wireless data users by 2005. You'd think that would calm the nervous Nellies a bit. (I do know that anyone who believes the analysts when they say bidding won't be as high here as it was in Europe is in for a surprise.)
NTT DoCoMo doesn't appear to be worried. It's seen firsthand the explosion of wireless Internet use at home. Others have taken note of the potential for wireless Internet, too, and they're not all carriers. America Online (AOL:NASDAQ) and Microsoft (MSFT:NASDAQ) have both been actively scouting for wireless partners. Either one would make a great partner for DoCoMo. I can think of a few other non-carrier companies who could enter the U.S. 3G spectrum auctions, but I'm going to keep them to myself for now.
How 'bout some numbers?
OK, 50-60K base stations in Japan. It's not a confirmed number, but a pretty reliable source has mentioned it as a ballpark figure. Assuming, of course, ISCO gets the bid, I asked CEO George Calhoun what kind of gross margins he hoped for. I mentioned 30-35% as a prompt and he scoffed. He said point blank that something this important that can't be had anywhere else is worth a lot more than a 30% margin. Based on the scoff, I look for gross margins to be in the 50-60% neighborhood. I like that neighborhood a lot better anyway.
If Illinois Superconductor gets the DoCoMo contract, I conservatively estimate revenues will be a minimum of US$300 million. Though no official statement has been released, I believe SK Telecom is involved in designing DoCoMo's network. And I believe orders from South Korea will follow sharply on the heels of DoCoMo, which should add another US$100 million. Near as I can tell, there isn't going to be any slow build-up to actual orders. One day there'll be none, next day there'll be scads.
Things to watch for
Couple things are coming down the pike for ISCO. I know if you've been following the company you've heard more than enough about the NASDAQ re-listing. The Spectral Solutions acquisition forced ISCO to re-submit all its paperwork, so it's going to be a while. In all honesty, I wouldn't worry about it. In the grand scheme of things, a NASDAQ listing is not that big of a deal. Sales are what's important now.
Be on the look out for new financing. ISCO needs cash, but they're taking the time to find the right kind of money. I'm sure ISCO has approached DoCoMo and some of the OEMs who are involved in the 3G network testing. A cash injection from any of these companies would immediately attract a lot of attention.
We should also anticipate another merger/acquisition or alliance-type announcement. ISCO needs marketing and distribution partners. And they also need manufacturing capacity in Southeast Asia or Japan. Keep your eyeballs peeled.
I originally recommended Illinois Superconductor as a strong speculative buy under US$5. The stock is hovering right above US$3 as I write this. I'm reiterating a strong speculative buy on Illinois Superconductor under US$5, though, with patience and barring any smashing good news, you should be able to buy shares under US$4. With speculation completely absent from the market, I'm not going to set a price target at this time. If the stock happens to run up to US$39 a share again, take your profits.
As always, I urge you to contact the company. Maureen Murnane is the investor relations representative. You can call her at (847) 391-9400. Illinois Superconductor is located at 451 Kingston Court, Mount Prospect, Illinois 60056. IR website: http://www.ilsc.com/cp_main.htm
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