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2HRS2GO: Court ruling doesn&#039t hide Diamond&#039s flaws

Yesterday's federal court ruling boosted the stock of Diamond Multimedia Inc. (Nasdaq: DIMD), but you have to wonder why, since it has no effect on the actual business.

Shares of Diamond Multimedia (Nasdaq: DIMD) are up almost 20 percent today after the 9th U.S. Circuit Court of Appeals upheld a previous opinion that confirmed the legality of MP3 players such as Diamond's Rio. It's the right decision; unfortunately, it doesn't change Diamond's recent numbers:

-- Results short of analyst estimates for the last four quarters

-- Declining gross margins in each of the last two years, to a paltry 11 percent in 1998, from 12.6 percent in 1997 and 18.9 percent in 1996.

-- Two consecutive years of losses



Diamond: Looking buff or rough?



MP3 players and home networking products may be Diamond's showcase products for the future, but for now, the company's core business remains 3D graphics cards, which generated about 60 percent of its revenue in the first quarter. Unfortunately, the field remains iffy.

Chipset suppliers such as nVidia Inc. and S3 (see below) stand to benefit as multimedia grows popular, but the cardmakers are busy driving each other into shorter product cycles, rapidly declining prices and as a result, falling margins. Diamond is trying to cut expenses and whittle down its notoriously large backlog, but all the cost controls in the world won't change the fact of price wars, both at the OEM level and in the retail space where Diamond mainly plays.

That's why the company is trying to diversify into things like Rio and home networking. But even those profitable segments face tougher outlooks.

The communications unit currently relies on sales of 56k modems, a business with a limited future at best, given the gradual rise of broadband. Home networking as an industry, let alone a single company's division, still has to prove itself. And the high profile MP3 unit will find the going tougher, now that at least four competitors have arrived to challenge Rio.

As someone who uses Diamond products -- this is being written on a computer that includes a Stealth graphics accelerator that does a fine job running 3D games -- I hope the company does well. People who aren't Diamond consumers should still root for anyone who tries to break the music distribution oligarchy.

But until Diamond produces sustainably positive numbers, it's hard to believe in the stock.

Other issues:

  • S3 Inc.
  • (Nasdaq: SIII) One of Diamond's suppliers seems to have a brighter future, at least according to BancBoston Robertson Stephens. Analysts Arnab K. Chanda and Daniel Niles today upgraded graphics chipset maker S3 to "buy" from "long-term attractive" and set a six-month price target of $15.

    S3 yesterday announced it would get 252 million shares -- worth about $500 million total -- of United Microelectronics Corp., a foundry operator based and publicly traded in Taiwan. The UMC stake, coming courtesy of a joint venture in which S3 has a 16 percent stake, gives S3 some currency to play with, Chanda and Niles note. S3 also stands to benefit as United Microelectronics does well in a recovering chip market worldwide.

    According to BancBoston's calculation, S3's current price implies the business will shrink, even though S3's Savage4 chipset is scoring design wins, including IBM and another top 5 PC maker soon to be announced, the BancBoston analysts believe.

    It's an attractive combination: new infusion of liquidity, combined with an undervalued stock and a business poised to grow. You could do a lot worse.

  • Sun Microsystems Inc.
  • (Nasdaq: SUNW) CEO Scott McNealy tells Congress not to fragment Microsoft; just destroy it as a viable business. Come on: stop Microsoft from buying new technology, but don't break the company up? You can see what he's thinking: take down my worst enemy, but take no action that might be a precedent for breaking up the monopoly (Java) my company hopes to develop for itself.

    Here's a not-so-novel idea for McNealy and all Microsoft bashers: run your business. As Sun's own history demonstrates, McNealy is very good at doing that, so why not stick to it, and let Microsoft's problems play themselves out?

  • Jabil Circuit Inc.
  • (NYSE: JBL) Looks like someone pulled out the party favors too soon. Maybe Solectron isn't such a bellwether after all. Or maybe Jabil just isn't as good. Either way, the overarching trend for the industry still looks positive.

    The overall technology market got a boost today from the Oracle Corp.'s upbeat quarterly report. With two hours left in regular trading, the Nasdaq Composite Index was up 79.98 to 2494.65, the S&P 500 had gained 24.60 to 1325.76, and the Dow Jones Industrial Average had risen 150.48 to 10745.38. 22GO>