The Chips Are Down but Not Out
By Aaron L. Task
Senior Writer
7/6/00 9:44 PM ET
SAN FRANCISCO -- If Salomon Smith Barney analyst Jonathan Joseph was trying make a name for himself with his controversial downgrade of the semiconductor industry Wednesday, he succeeded. Problem is, the name may not be fit for publication.
Joseph did not return calls seeking comment, and this column is not intended as a personal attack. The analyst has a right and a duty to speak his mind. Furthermore, he isn't some newcomer, having joined Salomon in early 1999 after a lengthy stint at NationsBanc Montgomery Securities and its predecessor.
But Joseph was just plain wrong -- or so early as to be bordering on rude -- in suggesting the chip cycle has peaked, according to a variety of sources.
"In the end, it's going to happen just like he sees it -- just not yet," said one West Coast short-seller. "I make my living shorting stocks, and I can't find anything negative."
The source, who requested anonymity, said he'd be tickled to think Joseph is right (or timely) but expects the industry's second-quarter conference calls to be uniformly positive. Seasonal factors could account for any current signs of slowing, he said, noting the second half has traditionally been stronger for chips because of back-to-school and holiday shopping, as well as spending by corporate IT chiefs faced with use-it-or-lose-it budget allocations.
As expected, a host of Joseph's peers on the sell side contradicted his call on Thursday. Typifying the offerings was a report by J.P. Morgan's Terry Ragsdale titled "End of the Cycle? We Don't Think So."
Most damning to some observers was that Glen Yeung, Salomon Smith Barney's chip-equipment analyst, defended his universe Thursday, all but contradicting his co-worker (while taking pains to not do so overtly).
Also, Morgan Stanley Dean Witter's Mark Edelstone and Lehman Brothers' Dan Niles -- top chip dogs in TSC's Analyst Rankings -- are both vacationing this week. If and when either heavyweight formally weighs in on the debate (Niles reportedly made some soothing calls to clients Thursday), expect the Philadelphia Stock Exchange Semiconductor Index to continue its rebound from Wednesday's drubbing. The SOX rose 4.5% Thursday, while the Nasdaq Composite gained 2.5%; the S&P 500 rose 0.7%, and the Dow finished down almost imperceptibly.
Most of those disputing Joseph's call agree the current chip cycle is only about 18 months old, having begun in late 1998 as Asian economies started their recovery from the currency crises of 1997 and 1998.
Given chip manufacturers wait several months into a new cycle before ordering new manufacturing equipment -- which itself takes time to be built, delivered and put on line -- the common thinking is that supply won't overtake demand until late 2001, at the earliest. And that's assuming demand remains stagnant.
That's critical because chip cycles have traditionally ended when supply overwhelms demand, leading to a steep drop in prices (vs. because of a steep downturn in demand itself).
As for the specifics of Joseph's call, the analyst's contention that spot prices for certain flash products are heading down raised the ire of several observers.
Joseph cited weakness in spot prices for 1 megabyte and 8 megabyte flash-memory products, which another sell-side analyst dubbed "last year's parts."
The analyst, who requested anonymity, observed 16 megabytes is now standard for flash-memory chips used in cell phones. Thus, weakness in spot prices for other products is understandable.
Additionally, "spot prices always decline at the end of [the] quarter because companies are getting graded more for being 'just in time' with zero inventory," added John Marren, a partner at Texas Pacific Group, a San Francisco leveraged buyout firm, which has large holdings in public chip companies such as GlobeSpan (GSPN:Nasdaq - news - boards). "No one wants to own inventory, so the spot market is always soft [at quarter's end]. It's pretty straightforward."
Marren, a sell-side analyst when the last chip cycle ended, conceded falling spot prices in 1994-95 were a leading indicator of the end of that cycle, and one overlooked by many observers at the time. But "we're in pretty good shape at this stage," he said, noting the favorable macro trends of strong and/or recovering economies in Asia, Europe and the U.S., plus increasing end markets for silicon.
Finally, Erik Gustafson, manager of the Liberty/Stein Roe Growth fund, took exception to Joseph's concern about rising inventories at contract manufacturers. Given the trend toward outsourcing, "it's only natural their inventory would increase," he said.
Stein Roe is long several chip and equipment stocks, including Atmel (ATML:Nasdaq - news - boards), Texas Instruments (TXN:NYSE - news - boards), LSI Logic (LSI:NYSE - news - boards), Maxim Integrated (MXIM:Nasdaq - news - boards), Applied Materials (AMAT:Nasdaq - news - boards), Novellus (NVLS:Nasdaq - news - boards), and KLA-Tencor (KLAC:Nasdaq - news - boards).
What's the Big Whoop?
Given the overwhelming consensus that Joseph is early/off the mark, there's still the question of why the SOX dumped more than 9% Wednesday in the wake of his call.
The obvious answer is the entire tech sector was rattled by the various earnings warnings in the software space, and there's been a psychological shift among investors since the spring swoon
Additionally, it's notoriously tough to foresee the end of chip cycles, so fund managers are quick to exit the group at the first hint.
One analyst said the difficulty calling the end is because when the going is good, companies with even "minute talent" at managing their finances will take some financial reserves. When the slowdown begins, the companies start calling on those reserves to smooth out their earnings, hiding the reality.
"Eventually, you hit the end of the reserves and haven't told anyone there's a slowdown," he said. "Because the numbers have been juiced up to artificial highs, [earnings] then falls off a cliff."
Whatever prompted Joseph's call and regardless of whether he's ultimately proven correct, his call certainly unveiled the lack of confidence among many investors.
Even Stein Roe's Gustafson, who said Joseph was "100% wrong," admitted doing very little regarding his stock holdings in the past two days -- save suffering the "body blows" on Wednesday and enjoying the rebound Thursday.
"We've got our troops out there trying to figure out if there's any validity to this call," he said. "We're redoubling efforts to make sure we're right. If we get confirmation, we'll be buyers."
Conviction, anyone?
thestreet.com
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Must have been one interesting day at SSB.
Jack |
