From 4/16/01 issue of Barron's:
Pricing pressure in Semi land
In its dispatch, the firm reminds us that the seeming stability of the gross margins of the semiconductor makers is rather deceptive in that it's the paradoxical result of the continued stream of cancellations and returns by chip customers. "If Cisco's trying to send components back to distribution/suppliers," Fechtor Detwiler points out, it's not exactly in a great position to dictate pricing. However, that's sure to change as those customers -- a/k/a original-equipment makers whose corporate shelves are groaning with chips -- whittle down their inventory.
The semi cycle, FD (forgive the familiarity, but it saves finger-wear) asserts, has two legs. The first takes the form of excess inventory; the second, severe pricing pressure. "We believe this second shoe is just getting laced up and is going to wreak havoc" on not only the industry's "revenue but also margins."
In some semiconductor areas, havoc already is being wreaked. MOSFETs, for example. The acronym, we're sure you're dying to learn, stands for metal oxide silicon field effect transistor, and it's a dandy little gizmo that, in effect, is a versatile and otherwise much advanced semiconductor version of the old electromechanical relay.
Dandy it may be, but makers of this power device are feeling the heat. For instance, Fechtor Detwiler reports, citing electronic-component distributors Arrow and Avnet, a company called STMicroelectronics "has offered to beat any competitor's price and guarantee a 30% margin to the distributor." That, FD drily comments, "is surely not going to help the margins at ON Semiconductor, International Rectifier, Fairchild and Toshiba."
The cruel truth is that the increasingly hard-pressed customers for chips of all kinds soon will be turning the meanies in their purchasing departments loose with orders to squeeze every supplier in sight. Especially bad news for the semi companies that grew rich and sassy supplying communication-equipment makers and have the rotten luck to be low men on the totem pole.
For the pain travels down the purchasing chain. To wit: The original makers of communication equipment reaped riches galore from what FD calls the "open checkbook" policies of such customers as the dot.coms, the established phone companies and the curious mutations known as CLECs (competitive local exchange carriers) and ASPs (not the venomous reptile, although shareholders might dispute that).
But now that the boom's gone bust, FD comments, and "these guys need to start showing a profit and must justify the return on investment for new hardware purchases, they're coming down hard" on the communication original-equipment makers. How hard? Well, "Sycamore, Cisco, Nortel, Lucent, Tellium, Cabletron and others" have gotten the word from their broadband-carrier customers that prices have to be shaved some 40%, or they needn't bother wasting their breath asking for new orders.
So, what do Sycamore, Cisco, Nortel, Lucent et al. do in response? Simple: They tug their corporate forelocks and then turn around and put the squeeze on their suppliers, most conspicuously including the chipmakers.
As Fechtor Detwiler relates, "Cabletron cordially invited its top 25 suppliers in this week in order to demand 40% price concessions." The problem, alas, is that most of the suppliers "don't have a spare 40% to give up and remain profitable, not to mention achieve double-digit growth rates."
As further evidence of how removed Wall Street is from the way things are in the semiconductor business, the firm cites the industry's mounting layoff toll and muses, "Could the semi companies be getting it all wrong? Aren't they going to miss the rebound scheduled to begin sometime this summer?" Well, apparently, news of the recovery hasn't yet made the rounds.
AVX, for instance, is "reportedly set to announce substantial layoffs (supposedly 22% of its workforce). There's talk in the trade, too, of "more Cisco pink slips, which could be passed out as early as Monday." And, adds FD, the recent IPO Agere Systems "is said to have quietly dismissed 250 employees at its Orlando facilities."
Finally, Fechtor, Detwiler insists that the semiconductor bulls don't seem to have a clue as to just how much excess inventory remains to be liquidated. Cisco, just by way of example, is still supposedly "struggling with absurd levels of finished-goods inventory," while its component inventory, the story is, runs a formidable $1.2 billion. Not especially encouraging for suppliers like chip makers, since the company is in the throes "of cutting weak programs and aggressively designing next-generation systems."
That prodigious pile of inventory, FD says, "may help explain why contract-manufacturing friends of ours are telling us that ... Cisco and its electronic-manufacturing-services-channel partners will be unloading some $800 million worth of excess DRAM inventory into the broker channel as early as next week."
Why do we have the feeling that the threat of such a monstrous dumping of DRAMs onto a limp market might not have fully registered on last week's hot and heavy buyers of Micron Technology? Keep in mind that Micron, according to FD, "will do approximately" $800 million in revenues this quarter, and the firm's DRAM contacts confide that "demand is nonexistent."
In brief, on closer inspection, that "bottom" in semiconductors appears nothing more than an optical illusion, a dreadful side effect, no doubt, of going so long without even a morsel of good news. Fechtor, Detwiler relays the sentiment of its distributor sources that, grim as the first quarter was, the second quarter will "most certainly be worse." |
