Intel Confab Bodes Ill for Chip Stocks
It was as if Moses came down from the mountain, but forgot to bring the
tablets. On Thursday, several hundred chip industry analysts and investors
converged on an auditorium in downtown San Jose for a four-hour briefing
from the brass at Intel. With growing concern on the Street that the
much-anticipated second-half recovery in corporate technology spending
might not materialize on schedule, there were hopes that Intel Chief Executive
Craig Barrett and his minions might offer a little insight on the state of the tech
and telecom markets.
Alas, the company didn't offer the faithful much to chew on. Barrett said 2002
revenue would be higher than 2001's; he even declared himself to be the most
optimistic he has been in his 30 years at Intel. But clearly, Barrett wasn't
referring to the short run. Telecom demand, Intel executives observed, shows
no signs of improving. And Intel isn't forecasting any increase in corporate IT
spending.
Perhaps unintentionally, Intel provided a sobering tidbit about the
semiconductor equipment sector. Dan Niles, Lehman's chip analyst, noted
that one slide presented by CFO Andy Bryant indicated that Intel's capital
spending in 2003 as a percentage of costs of good sold would dip a bit from
2002. Most analysts, Niles says, have been forecasting Intel's total cost of
goods sold in 2003 would rise about 10%, which suggests capital spending
for next year would be up less than 10% from the $5.5 billion budgeted for
2003. (Intel so far hasn't otherwise commented on 2003 capital spending
plans.)
A rise of less than 10% would seem fairly disappointing giving the high hopes
for a robust recovery: SEMI, the equipment industry trade group, has been
forecasting a 29% sales increase for next year. Given the healthy performance
of the equipment stocks this year, any moderation of expectations of the
coming recovery wouldn't be good news for the sector.
Niles, who has been advising Intel investors to "sell on strength," also sees
danger ahead for many mainstream chip stocks.
In recent months, he maintains, chip makers have benefited from overly
zealous inventory cutting done by personal computer makers in late 2001.
The result has been a need for the box makers to replenish inventory.
But Niles contends that inventories are nearly back to normal, which suggests
that sales growth in the second half of the year will require improving demand
from tech and telecom end markets. Expectations are high that Intel and other
chip makers will show a smart recovery in the year's last six months. But, so
far, no signs of an impending pickup have materialized. And, Niles notes,
valuations are rich.
Optional Accounting
Merrill Lynch chip analyst Joe Osha has some sobering observations about
the impact of stock options on the semiconductor sector. In a report last
week, Osha noted that expensing stock options would have reduced GAAP
net income for the chip companies he follows by 43% in 1999, 31% in 2000
and 69% in 2001. (GAAP stands for generally accepted accounting
principles.)
He also figures that tax benefits from options exercise accounted for 13% of
cash flow from operations in 1999, 26% in 2000 and 25% in 2001.
That's an important observation, and more than just a question of how to
present the data. As Osha notes, Michigan Sen. Carl Levin has proposed
legislation that would bar companies from taking a tax benefit from options
exercise unless they're also expensed on GAAP earnings statements.
"The result," he writes, "would either be a substantial reduction in GAAP
earnings -- or a reduction in cash flow as the tax benefit associated with
options exercise goes away."
One final thing: as Osha notes, options grants in the semiconductor industry
actually increased in 2001, despite the ugly technology downturn and
widespread layoffs.
Earth to Investors
In the March 18 Tech Trader column, I penned some kind words about
Earthlink, suggesting that, at $10 a share, the Internet-service provider looked
dirt cheap. The theory was that Earthlink has a clean balance sheet, improving
financial performance and a growing list of broadband customers via both
DSL and cable.
Well, if you liked Earthlink at 10, maybe you'll like it better at 8. That's about
where the shares ended last week, dropping about 22% after the company's
first-quarter revenue, cash flow and per-share loss all came in a bit below
expectations.
In an interview, Earthlink Chief Executive Gary Betty cited several factors that
hurt results. One issue, he says, involved customer churn. While churn
declined to 4.1% in the quarter, from 4.5% the previous quarter, he says it
was higher than the company would have liked in January, hurting revenue.
He also notes that Earthlink was hurt by higher promotional costs, particularly
for broadband.
Still, Betty says the company should reach $1.4 billion in revenue this year,
versus $1.25 billion in 2001. Earthlink's broadband customer base, he says, is
on track to rise by 250,000 to 300,000 this year, to as much as 771,000; the
first quarter's increase of 61,000 was a bit ahead of plan. Betty says the
company should generate cash flow this year of $75 million to $90 million,
including $6 million in the first quarter, and an expected $9 million to $14
million in the second. One contributor, he says, will be an expected $20
million reduction in communications costs in the second half alone.
The company burned a little cash in the quarter, and now has about $550
million on hand, with no debt. Book value is $4.50 a share. At the current
price, Earthlink has a market value of about $1.3 billion, less than one times
expected 2002 sales.
Betty says Earthlink should exit the year at an annualized run rate exceeding
$100 million in cash flow, defined as earnings before interest, taxes,
depreciation and amortization. If the company comes through, the stock
should rebound nicely. Snaps Betty: "Our business won't be trading at $8 a
share if we're generating $25 million a quarter in cash flow."
Got Game?
The video-game industry convenes in Los Angeles May 21 for the annual E3
trade show. The meeting lacks the drama of last year's event, which featured
big events on Microsoft's Xbox and Nintendo's GameCube. Nonetheless, the
show always gets the gaming community's juices flowing, with the debut of
many new titles. UBS Warburg notes that game stocks typically respond well
to E3, and he advises investors to be long the game software group going into
the show, in particular category leaders Activision and Electronic Arts.
Trendwatch
Do you think tech stocks are cheap? Insiders don't. Montreal-based BCA
Research noted last week that March insider trading data "showed an
alarming drop in purchases in the tech sector." Calling this an "ominous
development," BCA cautions that a continuation of the trend in April "would
paint a bearish picture for tech-sector profit prospects."
Another sobering development for tech investors is that growth funds, which
once devoted most of their portfolios to tech stocks, are scrambling to find
opportunities in other sectors.
David Readerman, a longtime software analyst who now is growth-stock
strategist for Thomas Weisel Partners in San Francisco, advises growth
investors to cast a wider net. He suggests growth managers look at
nonbiotech health-care stocks, retailers and defense contractors, even
brewers such as Coors and Anheuser-Busch.
"Tech will come back, but no one has certainty as to when," Readerman told
Plugged In during a break at the Intel meeting. "And it may take years to get
back to the previous revenue peaks." |
