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Investors, analysts fear chip boom has peaked

After reaping the rewards of a cyclical rebound in the semiconductor industry for much of this year, investors are grappling with when--not if--the next downturn will arrive.

After reaping the rewards of a cyclical rebound in the semiconductor industry for much of this year, investors are grappling with when--not if--the next downturn will arrive.

Many analysts and stock pickers already have concluded that the notoriously cyclical industry has peaked, and that it's time to do a little profit taking. Others argue that the industry remains healthy and that a recent correction merely reflects a more rational evaluation of the stocks.

For the past several weeks, the pessimists have been calling the shots, which can be seen in the performance of the Philadelphia semiconductor index.

After starting the year at 704, the index nearly doubled to 1,362 in March. But the index has since declined by about 30 percent, with much of the fall occurring in the past month, as shares of several big-name companies have retreated from their 52-week highs.

Intel trades around $62, compared with a 52-week high of $73.75 set in July. Shares of competitor Advanced Micro Devices hit a high of $97 this year but now trade around $61.

The makers of equipment used to create chips have not fared much better. KLA-Tencor peaked in March, when it set a 52-week high of $97.75--more than double the current price. Applied Materials shares trade around $70 today, well off their one-year high of $115 set in March.

While the shares of many tech companies have run into headwinds this year as investors have grown concerned about profits and growth, the semiconductor sector has been buffeted by different factors.

The industry is riding an unprecedented surge in demand. The problem, however, is that the industry regularly goes through boom-and-bust cycles--and many investors have apparently concluded that the risk posed by the inevitable downturn outweighs the rewards from the current boom.

In a report that provoked some controversy, Salomon Smith Barney analyst Jonathan Joseph last month predicted the downturn would take six to nine months to develop and downgraded the semiconductor sector to "neutral" from "outperform."

Analysts often measure the severity of shortages in semiconductor parts and commodities as a sign of the general health of the industry. For many, widespread shortages early this year were an obvious indication that the sector was booming.

But Joseph, while not sour on the entire industry, argued that supply in some commodities was increasing. Joseph also noted that unit shipment growth was slowing from a peak of 34 percent in February to about 30 percent in May.

"Supply is loosening in some commodities," Joseph said in an interview, "which suggests that availability is loosening."

He also said semiconductor sales were up a record 48 percent this June from last year, a rapid rate of growth that is not sustainable.

Others agree the shortages are fading. "We don't see a rapid increase in chip prices, which is the best sign of a shortage," said Risto Puhakka, vice president of VLSI Research, a firm that conducts research on the industry. "If there is a shortage, then prices would go up.

"If chip prices aren't going up, it might mean that the peak of the cycle is near," Puhakka added. "The industry is handling the cycle quite well, adding capacity as demand increases."

PC sales' influence
There is also a question about the strength of PC sales. "The PC industry hasn't been all that robust," said Dick Greene, an analyst at Semiconductor Equipment and Materials International (SEMI), an industry trade group.

"PC sales grew 14 to 18 percent for the second quarter year-to-year, depending on who you ask, and that's a ho-hum type of number," he said.

According to researcher International Data Corp., PC sales grew 23.4 percent in 1999 from the year before. IDC expects sales to increase about 18 percent this year.

"The growth rates of the drivers behind the current semi cycle, PCs and cell phones, are moderating. As such, the stocks are beginning to discount at a slower growth rate," Ashok Kumar, an analyst at U.S. Bancorp Piper Jaffray, said in a recent report.

Kumar expects "desktop growth rates to drop in half, from 18 percent this year to 8 percent in 2001. The strength in notebooks and servers will not offset the weakness in desktops."

Trouble in the wireless sector also has caused turmoil in the markets as Nokia, Ericsson and Motorola all cut their forecasts.

Kumar argues that growth in mobile handsets will expand at a compound annual rate of 16 percent, "well below consensus expectations." He also expects growing production capacity in cell phone chips to surpass demand by the summer of 2001.

Other analysts and industry insiders, however, argue a downturn will be temporary.

"Fundamentals are going strong for the third quarter," said Faye Hou, an associate at UBS Warburg who covers the technology sector. "Fundamentally, we don't see anything wrong, but psychologically, people are taking a glass-is-half-empty mentality."

Doug Andrey, an analyst at Semiconductor Industry Association, agreed: "People are thinking (the growth) is too good and can't last. The stock market (works on) its own dynamic."

Dan Niles, an analyst at Lehman Brothers who covers semiconductor and hardware makers, noted that the Philadelphia semiconductor index grew an astounding 40 percent from May 10 to June 21. As a result, Niles said the latest downturn was a seasonal correction that was anticipated, but "more severe than I thought."

Niles and Andrey predict the semiconductor sector will improve later this year. "PC sales are oriented towards the end of the year," Andrey said. "People buy a lot more computers for back-to-school and Christmas."

Milind Bedekar, a chip equipment analyst at Donaldson Lufkin & Jenrette, thinks sky-high investor expectations caused the volatility in chip stocks. "There was an overexuberance that's being ratcheted down," he said.

"If you asked (analysts) where the Philadelphia index would be at the end of the year, most of us would say somewhere between 1,000 and 1,100," he said. But the index reached that level in February.

"Cycles have historically turned because of pretty significant events, such as overcapacity or demand running off a cliff," Bedekar said. Oversupply in 1995 and a decline in demand caused by economic woes in Asia in 1997 were at the root of the last downturns.

"The rapid growth of the earlier quarters has surpassed us," said Min Pang, a chip equipment analyst at SG Cowen, who added that the industry is in "a transition phase of lower sequential growth but at a more sustainable pace."

Chipmakers have said that the future continues to look bright. "We are essentially sold out of flash (memory) through 2001," said John Greenagle, director of investor relations at AMD.

Both Intel and AMD continue to grapple with PC processor shortages because of greater than anticipated demand. Executives from Texas Instruments also recently reiterated their forecasts that 435 million handsets will ship this year. TI makes digital signal processors, the key component in cell phones.'s Michael Kanellos contributed to this report.