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2HRS2GO: ATI can only go up

COMMENTARY -- Skepticism dripped from the analyst asking this question during today's ATI Technologies (Nasdaq: ATYT) conference call:

"So you're pretty confident that the bloodletting in market share for you guys will stabilize going forward?"

The question was posed to ATI executives this morning, and it's a fair summary of what ATYT investors are wondering these days. But if you listened closely to this morning's call, you could have picked out signs of hope.

The maker of 3D graphics cards and integrated chipsets surprised no one when it slashed expectations for the fiscal second quarter ending February. The PC industry's slowdown is old news by now, and the only question was how much it would affect ATI.

ATI executives agreed with one analyst's assessment that a best case scenario for ATI's fiscal 2001 would be flat revenue growth and earnings of 10 to 15 cents per share. That's a far cry from First Call's consensus forecast going into the first quarter call; analysts previously predicted a 2001 profit of 39 cents per share.

That's the bad news. However, the bleeding has stopped, and the path has been laid out.

Last year was a financial nightmare for ATI, but ATI isn't losing money anymore. Growth may be slowed by the PC slump, yet the company isn't in danger of being driven out of the 3D business, unlike 3dfx (Nasdaq: TDFX) and S3, for example.

The departure of those weaker rivals can only help ATI, which now presents the only strong alternative to Nvidia (Nasdaq: NVID) in the high end, consumer mainstream and mobile 3D markets. It's a cleaner competitive landscape, which might help ATI nail down those coveted design wins with PC makers.

And ATI at least has a good product roadmap for this year: a mobile version of the Radeon due this quarter; another generation of integrated graphics chipsets for the Pentium; chips for Nintendo's next console, the Gamecube. If it can deliver on its announcements -- and the company has delivered on-time for its last several releases -- ATI will be keeping up with Nvidia's aggressiveness.

Scotia Capital analyst Gus Papageorgiou has a "hold" on ATI, but after today's call, he feels "a bit more favorable" toward the company.

"It's possible that they've seen the worst," Papageorgiou says. "If the PC market rebounds, ATI may be in a position to benefit."

There were a few disquieting signals from the call. ATI deludes itself in saying that the Radeon already matches the raw power of Nvidia's high end offerings when it clearly does not -- see recent benchmark tests from well-known tech Web site Anandtech, for example.

And though ATI knows it needs more OEM wins on the desktop, the company gave no concrete evidence of an Nvidia displacement. In fact, the next 3D graphics market research report is likely to show flat growth in ATI's desktop share, admitted David Orton, president and chief operating officer.

ATI needs to increase its PC bundles. The company's 3D cards are offered with machines from Acer, Apple Computer (Nasdaq: AAPL), Compaq Computer (NYSE: CPQ), Dell (Nasdaq: DELL), Gateway (NYSE: GTW) and IBM (NYSE: IBM), but only as an option, for the most part.

Nvidia not only remains the standard offering on most major PCs, but it's encroaching on other desktop strongholds. Nvidia's GeForce MX is now the default card for the most powerful PowerMac G4s unveiled by Apple this week. And Nvidia is finally attacking the laptop space, traditionally an ATI stronghold.

But all things considered, ATI appears poised to gradually improve. The company expects to cut operating expenses 3 percent sequentially each of the next few quarters, enough to carve out a small profit in a lousy time for the industry. If the company fulfills its promises, it should be in a relatively strong position going into the next fiscal year.

Wall Street currently values ATI at roughly $1.2 billion, which is less than the company's expected annual revenue, even after today's downgrade. That valuation by itself makes ATI worth watching.

"It's not necessarily a stock you want to get into right now," says Papageorgiou. "But it's something to keep an eye on."

That's more than you can say for a lot of tech stocks these days. 22GO>