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2HRS2GO: Analog Devices offers words of wisdom

COMMENTARY--The timing couldn't be better for a three-day weekend.

Networking equipment bombs should be part of the market's daily expectations by now, but evidently investors harbored some shreds of optimism. Wall Street is shaking today in the wake of horrid reports from Nortel Networks (NYSE: NT) and, to a lesser extent, Dell Computer (Nasdaq: DELL). Even Charlton Heston might be daunted by the Red Sea covering stocks today.

"Clearly there's a lot of angst in the marketplace," PNC Advisors' chief investment officer told Reuters. "The concerns are issues in the technology area and what is going to lead us out of the very slow growth we have at the moment."

Perhaps the holiday will calm everyone. It would help if people used the time to consider the words of Analog Devices (NYSE: ADI) CEO Jerald Fishman.

ADI reported first-quarter earnings yesterday. Like virtually every company associated with tech hardware, the maker of integrated circuits for computers and communications equipment also cut financial targets for the current quarter.

But after listening to Fishman--known for being a forthright guy--I found it difficult to worry too much. He wasn't trying to be soothing during last night's conference call with analysts. If anything, he was hedging as much as he could.

"That's based on a lot of assumptions," Fishman told an analyst who asked how secure he felt about the company's forecast of 20 percent revenue growth this year. "It's based on an assumption that the U.S. economy doesn't torpedo toward us. It's based on an assumption that some of these aggressive communications programs really start to come in, particularly toward the end of the year.

"All of those we think are good assumptions, but it would be not very smart of us to say we really have that dialed in, or in the bag. That is our best sense right now based on everything we know.

"But we don't have an extremely high rate of confidence on that."

I find that kind of candor far more reassuring than an unmitigated call for a rebound. Fishman's trademark honesty makes it easier to accept his other assertions, such as placing much of the industry's failure to anticipate a slowdown on outsourcing. Customers of Analog Devices and other chipmakers have shifted much of their work to contract manufacturers, which makes tracking inventory harder.

"One of the very common themes that we've heard from many customers, from our competitors, even from our customers, is how quickly things got bad," Fishman said. "And I think the reason for that has to do with how available the data was to companies like ADI, about what was really going on in the end markets. Because you have another inventory point. In some cases, you have two inventory points between the customer and the vendor: you have the subcontractors and you have the distributors.

"I think one of the very significant differences in this cycle is that (normally), you'd expect that as time went on, the information would be getting better; I think this (outsourcing trend) made the information get worse."

ADI and other chipmakers now have a better sense of how much product is held by subcontractors, so forecasting should be better. That means more realistic expectations, and proper stock valuations.

More important, if inventory data is the biggest difference between this downturn and previous slumps in the chip industry--and Fishman has seen all of them for the last two decades--then things should be fine in the long run.

"At the end of the day, it has many common elements to other cycles," Fishman said. "There were supply constraints. People over-ordered. People reserved places in line, and then as the supply got more available, people sort of said 'Well, we don't have to buy this stuff, after all.' "

Shekhar Wadeker of Dain Rauscher Wessels asked Fishman why the industry always seems to be taken aback by a slump after a long period of growth.

"You got me. We all look in the mirror and say 'We are good, aren't we?' " Fishman half-joked. "Then all of a sudden we wake up and say 'Well, what were we thinking when we grew 80 percent and we thought that's going to keep going?' There's some rationale for why the growth rate that we got last year was higher than normal, given the share gains that we were getting, but 80 percent is a little on the high side, don't you think?"

In other words, every surge has to end.

"There were a lot of issues in the end markets with PCs, obviously," Fishman noted. "And you know, the telco buildout has been at a pace that's just extraordinary, so the fact that things were going to quiet down a little in that segment isn't so surprising."

Which is why the news from Nortel shouldn't be too shocking today. Yes, we're in a downturn. It might take awhile to climb out.

But just as surges end, so do slumps, unless the industry is completely mature. Fortunately, the global communications network remains far from complete. Wireless handset sales may be slowing for now, but there remains a lot of wireless network infrastructure to build. Broadband remains in its infancy.

"It's always very tempting when any particular product family goes into a cycle to say 'Why the hell don't we get out of it?' " Fishman admitted. "But I think the way you build a franchise over 10 or 20 years is to decide what the compelling technologies you want to do and support those technologies, and that's what we're doing."

And that's what all good companies are doing, regardless of what's happening to Nortel stock today. 22GO>