Semiconductors . . . Zoran announced an agreement to acquire digital content distributor Oak Technology in a stock and cash deal valued at $358 million. Oak Tech stock is being valued at $5.88 each, a 24 percent premium. Zoran expects the transaction to be completed in the third quarter, and to be accretive to earnings in the first half of 2004.
CIBC World Markets downgraded PMC-Sierra to "sector underperformer" from "sector performer," citing relative valuation with its peers. James Jungjohann believes the stock is the "most expensive" in the sector, given that "much of the good news is in the stock." He said he would be "more positive" on the stock at a price of around $8.
Texas Instruments reaffirmed 2nd quarter outlook. In an 8-K document filed this morning with the SEC, co re-confirms its outlook for 2nd quarter as originally set forth in TXN's April 15 earnings release.
Positive commentary from the semiconductor industry has helped propel the Philadelphia Semiconductor Index (SOX) up 17% since late February. It looks like the low inventories and low spending were behind the 1st quarter upturn, and expect the SOX to head back down to the low end of its trading range over the coming quarter. However, analysts are not looking for a repeat of the
67% decline that the SOX saw from March to September of last year.
There is a widening gap in expectations between semiconductor companies and their customers. Comments from semiconductor companies were upbeat for the most part, while OEMs and distributors were more cautious. That’s been reflected in the performance of the SOX, which has outstripped the broader market and the rest of technology during the past few weeks.
Recently there have been signs that pointed towards low spending levels, low inventory and reasonable if not attractive valuation levels as reasons for the call. Much as most analysts would like to say that we anticipated a sharp upturn in semiconductor stocks, we didn’t. There was still-shaky end demand and most expected semiconductor stocks to remain stuck in a trading range.
No one is currently looking for the same dramatic, sustained decline we saw in semiconductor stock prices that began in the spring of 2002 – the SOX declined by 67% from March through September of last year. However, with the SOX at 343, up 17% since February 20, we’re at the high end of the trading range. Expect the SOX to move back down to the low end of the range, 270 to 280, during the second quarter. At that level we find the stocks in our universe are at or slightly below fair value looking both at decade-median multiples and our ROOC fair value calculation.
There are certainly similarities between the situation in which we find ourselves now and where we were in spring 2002. The quarterly supply chain analysis shows inventories ticking up for the first time since 1st quarter of last year. At the same time feedback from OEMs and distributors at our conference was mostly negative, and a look at macroeconomic indicators that have been good predictors of semiconductor revenue growth in the past is not encouraging.
It is important to also note that normal seasonal patterns, which were working for semiconductor investors in the March quarter, should be less helpful as we move through the second quarter. The June quarter typically sees a sequential progression in growth, just like the March quarter, but the progression is normally more muted than the March quarter as the figure below illustrates. Given the market’s recent willingness to trade semiconductor stocks up and down based on normal seasonality, expect the usual round of channel checks to begin turning up summer “weakness” in mid May. That in turn is likely to put intermediate-term pressure on semiconductor stocks.
There are however some important differences between now and last spring. A repeat of the disastrous 67% decline in the SOX that occurred between March and September of last year is unlikely, which is why we’re sticking with our neutral stance despite our belief that a near-term trading decline is in the cards.
Three factors deserve attention, as follows:
* Inventories may be up, but they are not as high as last year, and still low by historical standards. Inventories may be up from the December quarter, but they’re still below March 2002 levels, and at the low end of the range for the decade. Analysis shows PC inventories as of March at 45 days as compared to 50 a year ago. Wireless handsets are at 51 days versus 57 a year ago, and the decade averages for both supply chains are higher still. The PC business in particular has become better at managing inventory, but don’t think there is evidence to support a real inventory crisis scenario.
* Expectations are more reasonable than they were last year. In April of last year the revenue and earnings estimates on the street incorporated strong expectations relative to history. Prior to downgrading we re-examined our own numbers, which weren’t far from consensus, and realized that we were looking for an above-average second quarter and a remarkably strong fourth quarter. As it turned out, the fourth quarter was a disappointment, only growing 2% sequentially, but even without knowing what was going to happen it was clear that expectations were too upbeat.
This year, however, expectations are meaningfully lower, especially for the fourth quarter. Also note that we’re running our numbers off a lower absolute basis. While not a certainly, there is much less risk to our numbers than there was last year.
* Valuation is more reasonable now. It’s also notable how much more inexpensive stocks are than they were last year, in dollar terms and in valuation terms. The SOX was above 600 in spring 2002 – it’s currently just above 300. Earnings multiples are also much lower, on numbers that companies are much more likely to make.
Boxmakers . . . The New York Times reported that Hewlett-Packard’s $3 billion cost-cutting effort poses a serious challenge to its ability to innovate in the fast-consolidating computer industry, according to analysts; in addition, many outside experts on corporate research say it is still an open question whether the company can rekindle the synergies it once enjoyed in computing and materials science research before 1999, when it spun off Agilent, its scientific equipment and medical instrument business. HP plans to update enterprise computing systems and services strategy in press/customer briefing at 9am PT on 5/6. New structure will more tightly integrate high end server and x86 server units as well as storage and management will reiterate commitment to take ESG into black in 2nd half.
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