Broadcom drops on downgrade, demand concerns

Merrill Lynch analyst Joseph Osha cut the company's stock to intermediate-term "neutral" from "accumulate," while the analyst Clark Westmont at Salomon Smith Barney dropped the company from "buy" to "outperform".

Shares of the communication chipmaker, which was downgraded last month at CS First Boston, touched a new 52-week low of $40.75 earlier in the day. By market close, shares recovered to $48, down more than 2 percent.

Broadcom's integrated circuits are used in over 90 percent of cable modems and digital set-top boxes. They are also used in digital subscriber line, satellite and terrestrial broadcasting, home networking, and wireless devices. Broadcom shares have been rattled of late as many of its major customers issues profit warnings.

Other chipmakers felt the pinch, as well: Applied Micro Circuits fell $2, or 7.46 percent, to $24.75; Vitesse Semiconductor slipped $0.44 to $39; and PMC-Sierra dropped $1.50, or 4.48 percent, to $32 before the opening bell.

The thesis underlying both downgrades was the deteriorating economy. "While the company is exceptionally well run, and has an excellent reputation for execution, we believe it faces a number of challenges that are not fully factored into the stock," Osha wrote in his research note.

Osha, who also slashed 2001 and 2002 estimates on the company, specifically highlighted an inventory buildup in cable modem chip sets, which the analyst said was caused by a failure of new cable modem subscribers to keep pace with sales of chipsets.

The Merrill Lynch analyst also note the increased competitive pressures and lower growth rates in the company's local area network (LAN) business. The prospect of a gigabit Ethernet price war was also fingered last month by CS First Boston analyst Charles Glavin, who cut Broadcom from "hold" from "buy," slashed 2001 earnings estimates and lowered the company's 12-month price target to $80.

As well, problems at Broadcom's customers--most notably 3Com, which yesterday warned for its third quarter, Cisco and Motorola--were also front and center.

According to Westmont, the fact that these three company's account for 54 percent of Broadcom's sales will be an especially large challenge for the company. The analyst also said the situation is unlikely to improve for another six months.

The Salomon Smith Barney analyst also brought up the issue of the company's use of warrants to strengthen ties with its customers, a practice that Westmont believed leaves many investors uncomfortable. The analyst also cut estimates for 2001 and 2002.

Both Osha and Westmont remained positive on the longer-term outlook of the company, however.

"We believe that longer-term investors will find attractive entry points over the next several months as companies formally reset expectations," Osha noted.