Strategist bets on networking chips
By Mike Tarsala, CBS.MarketWatch.com
Last Update: 12:01 AM ET Oct. 3, 2001
SAN FRANCISCO (CBS.MW) -- Greg McClenon is either overly ambitious or out of
his gourd.
Or maybe the research director and Hotovec & Pomeranz knows something about the
communications chip market that the rest of us don't.
McClenon says the best tech bargains in the market are shares of volatile networking
chipmakers including Vitesse Semiconductor PMC Sierra, and Advanced Micro
Circuits -- three tortured tech companies that are among the ultimate market dogs.
Most analysts say they're a year-and-a-half away or more from turning a profit.
While counterparts at other research firms are calling him "nuts" behind the scenes --
"he'll lose his shirt," one says -- McClenon believes he's found a rose in one of the
market's smelliest trash heaps.
"We're seeing signs that the order rates are coming back a little bit," the long-time
analyst and former chip industry executive and engineer said. "It's nothing robust, but
the book-to-bill ratios are starting to even out. In the next three weeks, when we hear
quarterly announcements, we'll see the companies say they expect sales will be up
quarter-over-quarter going into December."
McClenon makes a case for the stocks
based on historic valuation measures. He
points out that Vitesse's (VTSS: news,
chart, profile) ratio of its stock price
divided by its bookings is lower than at
any point since 1995, or since the
company switched from making
supercomputer chips to networking chips.
It historically trades at 10 times its sales,
and is now at 2.9 times sales.
PMC
Sierra's
(PMCS:
news,
chart,
profile)
price-to-sales
ratio
hasn't
been
this
low
since
1990, McClenon says.
The company's price-to-book ratio also is at a 10-year low.
Applied Micro Circuits (AMCC: news,
chart, profile) has only been public since
1997. But it's trading at 4.8 times sales,
its lowest level since 1998, and one of its
lowest levels ever. Its price-to-book is at a
historic low.
Money where his mouth is
Analysts and strategists in general have
been so wrong in the past. At least a
dozen have jumped the gun on
networking chip stocks in the past year alone. Why even register what McClenon
says?
This time, a head strategist is putting his own skin behind the stocks. McClenon
recently purchased PMC Sierra shares at around $10 for his own personal account
and says he's waiting to buy the other two companies on share weakness or
significant news.
Plus, he's had some great calls in the chip sector this year. He told investors to bet
on shares of Transmeta sinking in early February, when it was at $34.69. It's now at
$1.31. He told clients to short Rambus in February when it traded at $40.63, and it
now trades at $7. He told investors to buy Nvidia at $23.44 in March, and it climbed to
$46 in a little more than two months.
McClenon says he's committed to holding PMC Sierra's shares until after it releases
third-quarter financial results. While he sees the possibility of a fourth-quarter stock
slide, he claims the companies could provide long-term returns, and he fully expects
them to be in business three years from now.
No signs of good news
Investors recently scorched by the stocks must think McClenon is nuts. Vitesse and
PMC Sierra shares each are down 87 percent since the start of the year, while
Advanced Micro Circuit shares are down 91 percent. While the stock valuations have
come down, there's little economic, market or company-specific news to suggest a
reversal of their long stock slide.
Each of the chip companies supplies networking-equipment makers such as Cisco
and Lucent - large companies that have been among the hardest hit during the tech
downturn. There are few signs that those customers have increasing product
demand, due to excess inventory. Nortel Networks, another such customer, just
warned for its upcoming quarter, and announced additional job cuts.
It's easy to point out a half-dozen negative influences on the networking chip sector --
horrible year-ago comparisons, large write-offs, macroeconomic exposure, workforce
reductions, facility consolidations, and overall rotten market sentiment.
"There's a point where you'll want to own them, but there's more bad news to come,"
said Karl Motey, analyst with First Union Securities, who has completed one of the
most comprehensive reports on networking-chip stock valuations. "It might be dead
money for the next quarter if you bought it here."
Motey says there are few catalysts to move the networking-chip stocks through the
end of the year. Based on historical comparisons, he says stock prices are going
lower before they hit a trough.
All three companies McClenon recommends have badly missed year-ago financial
targets for the past year-and-a-half. They've gone relatively ignored by investors --
except for short-sellers -- for months. Wall Street analysts are almost universally
negative on the three companies.
When Vitesse reports this month, it's expected to post a 13-cent loss, compared with
a 21-cent gain in the same period last year, according to Thomson Financial/First
Call. Sales are expected to decline 72 percent from the year-ago quarter, and 36
percent from last year.
PMC is supposed to report a loss of 18 cents a share, compared with a 31-cent gain
in the same period last year. Sales are expected to drop 68 percent from the year-ago
period, and 33 percent from the previous quarter, according to Thomson Financial/
First Call's consensus.
Applied Micro is barely better. It's expected to lose 5 cents a share, compared with a
13-cent gain in the year-ago period. Sales will drop 57 percent from the same period
last year, and they'll increase only a tiny bit from $41 million last quarter.
What all three companies have to say about the fourth quarter will be key. But many
analysts are saying that it can't be good news.
Waiting for a turnaround
"Three will be some pretty bad guidance for the fourth quarter in all of these stocks,
and the networking systems companies will still be showing declines," said Arnab
Chanda, analyst with Lehman Bros. "We think the end of the year is the soonest we'd
see a turnaround in the stocks. And business won't increase until the third quarter of
next year."
Brian Piccioni, analyst with BMO Nesbitt Burns in Toronto, is waiting for Cisco CEO
John Chambers to say that his company is showing concrete signs of better
demand, which would help all the networking chipmakers. Piccioni says we're no
closer to hearing that speech this month than last. He's cautious on the entire sector.
Going into the early part of next year, networking chip demand could get even worse,
warns Paul Brandeis, analyst with Needham & Co. He points out that other historic
multiples including price-to-sales indicate that the stocks still have a ways to fall.
No matter what the crowd says, McClenon says the market is saying something else.
He's happy to zig while the rest zag.
"It's one of those stories when the bad news is already in the stocks," he says. The
valuation is fantastic, and the gloom-and-doom is built into the stock price."
It's hard to tell if he's brilliant or crazy. Maybe both. |
