From Merrill Lynch--9\18
Global Semiconductor Update: Monthly Conference Call (Joe Osha 415-676-3510/ Global Semiconductor Team)
• With the August Taiwan semiconductor production data in hand, we conducted our monthly overview of the semiconductor industry.
Total semiconductor billings from Taiwan companies were flat (0.8% MoM), which was well below the normally strong August pick-up
of 7-8%. Despite the relatively weak semiconductor billings numbers from Taiwan, we believe fabless companies are starting to
deplete inventory. Our hypothesis is supported by our Foundry-Fabless Growth Differential (FFD) statistic, which swung from +8.5%
in July to -2.6% in the month.
• In our recently published industry report, “Return of the Chip”, we spent some time investigating the long-term returns of the industry.
We examined 40 leading semiconductor companies and tracked return on invested capital (ROIC) as far as data were available. Two-thirds
of these companies turned up with average returns above 10%. The semiconductor industry is not a homogenous sector,
however, and we should not be generic about investing in semis. Please refer to “Return of the Chip”, published September 6th, for
complete details on our valuation study.
• U.S. semiconductor stocks have sold off in recent weeks, but we do not think we’ve reached the entry point yet. Price to book value
indicates that my group is well valued at 1.3x, considering that the October-98 trough was 3.4x, and 2.4x excluding the bias for high
comm-IC multiples. However, we are inclined to give more weight to price earnings valuation, which shows that we are still at about
25x P/E, versus a decade average of 19x and an Oct-98 trough average of 18x. Utilization rates trended up to 69.4% in August in U.S.
from 68.5% according to the Federal Reserve, and represented the 12 th consecutive month of improvement. We believe the trend
contrasts with the declining foundry utilization Dan Heyler is seeing in Taiwan for two reasons. First, Taiwan foundry suppliers have
had to deal with excess inventory, which was not a factor in the U.S. Second, with the exception of Intel, U.S. IDMs have not been
adding capacity as rapidly as TSM or UMC. There have also been a number of fab shutdowns in the U.S.
Telecommunications Equipment: Spotlight on NFOEC Tradeshow (Tal Liani 212 449-0725/Simon Leopold 212-449-9748)
• We attended the National Fiber Optic Engineers Conference in Dallas and found a universally bleak outlook; however, we see
interesting industry trends. In our discussions with vendors and carriers, we could not find anyone willing to argue with our view that
a recovery occurs no sooner than 1H04. Furthermore, the developing consensus appears that the recovery begins at the network edge
and works towards the core over time.
• Big picture trends: 1.Catalysts for a recovery could include fixing the regulatory environment and the introduction of a profitable
killer application. 2. The number of start-ups hoping to break in remains a bit puzzling, but we believe the incumbent suppliers are
more likely to enter OEM partnerships. 3. Although we hear that carrier labs are running at capacity evaluating optical systems, we
remain suspicious that the money will not follow any time soon.
• Competition in the grooming optical switch space could get exciting once carriers begin spending. We see an interesting dynamic
among Ciena (CIEN; $3.89;C -3-9) Volatility Risk: High, Cisco (CSCO; $12.54; C-1-9) Volatility Risk: High, and Lucent (LU;
$1.00; C-2-9) Volatility Risk: High. We met with Ciena management, and continue to see the company’s best prospects in the
optical switch market. We still struggle to see how revenue can grow or costs can decline to return the company to profitability. Our
discussions with Tellabs provided several interesting points supporting sales recovery, and our channel checks during the show
suggested that elements of our segment model could prove to be conservative. However, the rapid decline of TITAN 5500 sales could
overshadow the positives.
fred |
