Chip debate turns into pity party

Investors in semiconductor and chip-equipment stocks still have no clear-cut answer to their burning question: When's the pain going to end?

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  Intel expects improvements
Andy Bryant, CFO, Intel
Investors in semiconductor and chip-equipment stocks were deluged with earnings reports, a flurry of analyst comments and sweeping price cuts in the past two days, and there's still no clear-cut answer to the most important question: When's the pain going to end?

The simple answer is that no one knows. At this point, financial and industry analysts (to say nothing of the companies themselves) are only comfortable projecting when this much-needed upturn is not going to happen.

Back in January, when Rome was just starting to smolder, everyone assumed the second half of 2001 would mark the beginning of the end to disappointing sales and earnings for the big chip and equipment makers. Factoring in the predictable seasonal dip for the second quarter, most analysts were projecting a modest rebound by year's end.

Salomon Smith Barney chip analyst Jonathan Joseph, who at this time last year advised investors to unload their chip holdings at or near their apex, was the first to suggest a recovery was near when he upgraded the entire sector in April and identified Intel, Micron Technology and Texas Instruments as strong individual investment ideas.

"Never in our experience have we heard stories of prominent semiconductor makers reporting no net bookings in the quarter, shipments for good, if not great, component suppliers falling 50 percent quarter on quarter and distributors reporting a 65 percent sequential decline in demand," he wrote in the research report in April.

Surely business had to improve from these levels, Joseph thought, and soon these beaten-down stocks would be making impressive recoveries.

Well, it hasn't panned out--not by any measure. Since the analyst's April 11 call, Texas Instruments has drifted from $34 a share to around $30, and Micron has slid from $41.60 to about $37. Even Intel, which got a nice boost immediately after the upgrade, is up only a few cents for the same period.

Last week, Intel archenemy Advanced Micro Devices barely topped downwardly revised estimates in its latest quarter, but--more telling--it warned that microprocessor and flash-memory chip sales will disappoint in the next couple of quarters due to a vicious pricing war with Intel and sluggish demand.

Then Applied Materials chimed in with its own bad news Monday, telling investors that there's no clear indication of when its business will improve. Novellus Systems' lackluster second-quarter earnings and third-quarter forecast didn't help matters much either.

On Tuesday, Intel topped estimates in its second quarter, but sales of $6.3 billion were nearly $2 billion lower compared with a year ago. The company said its third-quarter sales would be roughly in line with First Call consensus estimates, but that outlook came with a hedge. The company said "continuing uncertainty in global economic conditions make it particularly difficult to predict product demand and other related matters."

Intel said it would provide a more detailed update on a midquarter conference call Sept. 6.

"The issue right now is there really is no visibility," said Dan Scovel, an analyst at Needham & Co. "I don't think anyone cares too much about what happened last quarter. Everyone knows it was ugly."

There are signs that PC chip inventories have cleared out in recent quarters, but the networking and telecommunications chips that contributed so much to the tremendous growth in 1999 and 2000 are still stuck in a miserable tailspin. It could take as much as a year to clear out that inventory glut, analysts said.

As if this sector needed more bad news, the trade association Semiconductor Equipment and Materials International (SEMI) on Tuesday predicted this year's sales would fall 35 percent from 2000 and that chip-equipment makers would not be likely to see a return to 2000 levels until at least 2004.

Talk about your long-term outlook.

Assuming that inventories do clear out by year's end and there's a significant recovery in the U.S. and world economies, investors likely won't see any marked improvement to their portfolios until the latter half of 2002 because of the seasonality of the chip industry. Business conditions might improve, but chipmakers will still run smack into what's historically their weakest quarter in the second quarter of 2002.

And when this rebound does come, don't expect it to resemble anything like the monster rallies enjoyed in the past four years, analysts said.

Finally, there's the pricing issue.

Both AMD and Intel have dramatically reduced prices in recent months, hoping to salvage whatever profits they can manage while providing a little window dressing for the institutional investors.

Intel cut prices on its fastest Pentium III mobile processors, both introduced in March, by 37 percent this week, illustrating the aggressive and, perhaps, desperate position it finds itself in as PC prices continue to plummet.

"The price cuts wouldn't be such a big issue had Intel and AMD not already started slashing prices earlier this year," Scovel said. "There's concern that business might improve in the next few quarters but it won't be reflected in the companies' financials because of the price erosion."

The semiconductor industry has seen more than its fair share of boom-and-bust cycles in the past, but none have come on the heels of such unprecedented growth, making this past year (and presumably the next one) much more difficult to stomach or predict.

"The truth is that anyone who predicts an upturn at any point in the future is just guessing," Scovel said. "No one's going to know jack until the third week of September."

At this point, it's hard to say if he means the third week of this September or next.