TECH WRECK STILL IN PROGRESS
by Fred Hickey 07:00 AM 07|27|2001
Don't be fooled by the noise. The 'unprecedented' downturn is not over, and there's plenty more earnings disappointment on the way.
Each month we're all bombarded with biased bits of information that can skew the opinion-making process. All of this noise from mostly biased sources can lead us to the wrong conclusions time and again. Indeed, the drumbeats of positive opinion were so loud this month and in such unison that even I was partially swayed. That is, until I completed the process of preparing to write this newsletter. As I considered the rising mountain of hard evidence, it became clear that we are being conned in a massive fashion.
The economy is sinking. The technology sector is in its deepest recession ever. Stocks are overpriced. These are the hard truths that no one wants us to know. As Barton Biggs, chairman of Morgan Stanley Dean Witter Investment Management, said recently, "It still boggles my imagination that everybody thinks we can come through the biggest bubble in the history of the world and certainly the longest boom that the U.S. economy has ever had, and get out of it with a very, very mild recession. Is that the way it works?"
Cell Phone Woes
Investors clung to hopeless optimism that the wireless industry had seen its worst moments, due to bullish hype from worldwide cell phone leader Nokia (37% market share in Q1). Up until last month, Nokia had held to an industry forecast of 450 million to 500 million handset sales this year, even though the rest of the industry had given up on that hope. Stock prices of cell phone suppliers like Texas Instruments and RF Micro Devices had sharply risen on such optimism.
Nokia finally dashed the dream last month with a "shocking" (not to me -- it was one of my short/put option positions, as noted in past letters) Q2 earnings warning. Nokia halved its sales growth forecast for the quarter from 20% to less than 10% year-over-year, and cut earnings estimates by about 25%, to 14 cents per share (down 22% year-over-year). Nokia also lowered its forecast for cell phone sales to just above last year's 405 million tally. In its press release, Nokia acknowledged that "the general economic slowdown in the U.S. has recently shown signs of extending to other regions and to the wireless telecom industry as a whole." Though Nokia's stock was hammered on the warning, it still sells at 34 times estimated earnings. . . . If world-beater Nokia is sick, then its competitors must be near death (which they are). The head of Ericsson's Mobile Systems Group also admitted last week that he did not see any sign of recovery in the U.S. cell phone market.
The continuing cell phone glut is hurting another group of semiconductor suppliers. . . . Texas Instruments (TXN), the leading U.S. semiconductor supplier to the cell phone industry, announced that it would idle two factories in Texas for three weeks this month. A distributor contact told me that they're also considering a similar shutdown in December. TXN's chief operating officer recently admitted that there had been no improvement in business conditions in the second quarter. . . . It makes you wonder how investors can justify paying 100 times estimated 2001 earnings for TXN. On a price/sales basis, TXN (at a $57 billion market valuation) sells at 6.5 times 2001 estimated sales and nearly six times 2002 estimated sales. For comparison purposes, TXN's price/sales ratio in 1998 was 2.5 times, in 1995 it was 0.8 times and in 1991 it was 0.45 times sales.
Can PCs Save the Tech World?
The No. 1 driver of the tech industry is still the PC. It is by far the largest end market for semiconductors. Research house IDC issued a new forecast for the PC industry last month. For the first time ever, IDC predicts a decline in U.S. PC shipments year-over-year. IDC analyst Roger Kay stated, "This is an indication of a PC industry recession that will last for the next two years due to anemic sales, followed by a modest recovery in 2003." U.S. PC sales are expected to decline 6.3% (in units) in 2001, with particularly slow sales in the second half. IDC also slashed its forecasts for worldwide growth in half, to 5.8%, as IDC sees slowing demand in Japan and Europe.
PCs are more like an anchor than a savior. According to the Daiwa Institute of Research, May sales for Taiwanese-listed electronic companies plunged 12% and inventories were "piling up" due to shrinking demand. Taiwan's export orders in April plunged 7% year-over-year due to slackening U.S. demand and a 21% plunge in exports in Europe. Taiwan's economy was the slowest it's been in 26 years in Q1. May's unemployment rate hit a 16-year high. The primary cause of Taiwan's troubles is the imploding tech market, due to slumping PC, cell phone and networking equipment consumption.
To sum up, there basically is no evidence whatsoever to support the bullish opinion of a second-half rebound in the technology world. The bull's case is built upon faith in the Fed and faith in Mr. Greenspan. I've argued the case against this belief before, and will not rehash the argument here. However, we're now in the seventh month since the dramatic interest rate slashing began, and, to date, all I see are worsening conditions in the tech industry and economic conditions worldwide. Tech stock prices reflect a second-half pickup. With tech stock prices still in the stratosphere (see last month's valuation chart -- an average P/E greater than 50 for the highest valued tech stocks), there's no room for any more disappointments.
The pressure is building for another leg down in the Nasdaq and tech stocks. Maybe this time, the Dow Jones Industrial Average will be taken down, too. The catalyst could be the third-quarter and second-half warnings that I expect from tech companies. Many of the estimates for Q3 assume significant improvements from Q2. The improvements will not happen. AMD cannot make 32 cents per share in Q3. Compaq will not make 13 cents (another round of layoffs is in process). Business at Maxim Integrated Products and Linear Tech will not improve in Q3. There's no chance that Applied Materials can report better earnings next quarter, given the current state of its backlog. . . . I don't know how IBM can make Q2 numbers, never mind the second half's. IBM's mainframe upgrade cycle has ended. I'm told the disk drive business is in terrible shape. PC margins industrywide are being devastated by Dell's scorched-earth price war.
As for DRAM disasters, Micron did report its biggest loss in history, as I expected. The problem was, no one cared. We'll get another chance for investors to care when Micron reports an even bigger loss next quarter. Spot DRAM prices are currently down another 50% from last quarter's average selling price. That means that revenue could come in at $600 million or less for the August quarter vs. $2.3 billion a year ago. Micron could almost lose as much money (half a billion dollars, before write-offs) as it has in sales this quarter. Micron cannot maintain its outrageous $24 billion market valuation given these circumstances. Every major semiconductor company in the world is cutting estimates. There's no way that Applied Materials, Novellus and KLA earnings estimates can hold up.
Fred Hickey is editor of The High-Tech Strategist. This story is adapted from the July issue. |
