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2HRS2GO: PC chipmakers face tough, cheap market

COMMENTARY -- No one was surprised by yesterday's warning from chipmaker Advanced Micro Devices (NYSE: AMD), but don't look for an immediate resumption of record growth.

AMD got the same surface reactions as competitor Intel (Nasdaq: INTC) last week. Just as Intel (Nasdaq: INTC) stock gained value on Friday after that company's preannouncement, AMD received a slight bounce today following its caution about lower-than-expected fourth quarter results. AMD shares were up about 1 percent in early afternoon trading.

That stock price gain shows investor doubts have been largely resolved, but not enough to power a huge burst. There won't be one in the next couple of quarters, if Wall Street analysts are correct:

  • Dan Niles, Lehman Brothers:
  • "We remain cautious as we believe the macro demand environment is getting worse and we don't expect the fundamentals to bottom until the summer at the earliest. We believe the current reflex rally in semiconductors is almost over as well with about a 25 percent increase in the SOX (Philadelphia Semiconductor Index) off the bottom."

  • Eric Rothdeutsch, Robertson Stephens:
  • "We continue to remain cautious pending better visibility into some sort of pickup in overall PC demand, improved motherboard build rates, and lower chipset inventories. We are more optimistic about the prospects for the (second half 2001) given what should be an accelerating Windows 2K/ME adoption rate and the growing demand for home PCs offering increased Internet-access capabilities. We believe the company continues to gain market share from Intel."

  • Drew Peck, SG Cowen:
  • "Although INTC rallied after its pre-announcement, investors should not assume that all the bad news is out, especially regarding PC components. The specter of 5 million to 8 million units in incremental inventory does not bode well for Q1. We think AMD and Intel are likely to materially lower guidance for Q1 when they announce Q4 results. As we've noted before, the inevitable impact will be on pricing, which will remain weak through most of 2001."

  • Mark Edelstone, Morgan Stanley Dean Witter:
  • "With slower than expected PC sales, higher inventory levels are likely to lead to a challenging first quarter environment for microprocessor vendors."

    Niles, Peck and Edelstone have "neutral" ratings on AMD. Rothdeutsch maintains a "long-term attractive" advisory, which boils down to "ok, but not great."

    Not everyone agrees with AMD CEO Jerry Sanders' assertion that the PC demand slowdown is temporary; you could argue that the PC market is becoming saturated in the industrialized world. In any case, at least part of the AMD's miss was self-inflicted, because the company pushed out its low-end Duron chips before an integrated graphics chipset was widely available. AMD says that won't be a problem in the first quarter.

    Whether demand resumes in the first quarter or not -- and even AMD seems to be hedging its bets there, judging by the fact that the company declined to release a March quarter outlook -- clearly chip prices are falling. Niles estimates AMD's average selling price will drop to $87 from $96, as the chipmakers flush out inventories.

    AMD says it will sell out its entire Athlon production this quarter. But at what cost? Chase H&Q analyst Sudeep Balain sees an average price of $102 per Athlon, down 8 percent from $111 in the previous quarter. And there no guarantees that price will stabilize; Intel already sees price cuts for the Pentium 4, less than a month after the chip's debut.

    Personally, I love this situation. Falling prices convinced me to buy an AMD machine from Gateway (NYSE: GTW) recently. This column is being written on it.

    But professionally, I loathe the trend. AMD might be gaining market share, but it's hard to get excited when the market has become unkind. Microprocessors have turned into commodities these days, and it will only get worse as AMD and Intel continue to ramp up chip speeds.

    People are blaming the economy for hurting demand, but even if consumer confidence suddenly shoots to a new high, there is no compelling reason to buy the latest products from AMD and Intel.

    No one needs 1.2 GHz chips right now, let alone 1.5 or 1.7 or whatever speeds these companies promise in the future. You can run any commercially available application right now on an 800 MHz processor. Even power-hungry software such as design programs and 3D games run decently on chips far below the top end of the spectrum.

    Faced with such a paucity of need, AMD and Intel can only push processors by selling them at lower prices. Unfortunately, cheap product doesn't make for a compelling investment story, particularly in the world of tech stocks.

    At least Intel in recent years has been trying to broaden its revenue base with markets such as broadband communications. On the other hand, AMD's only significant non-processor revenue stream comes from flash memory chips -- another commodity market.

    Pork bellies, anyone? 22GO>