From Barron's:
A (Business) Model Gets a Facelift
TIMES THEY ARE CHANGIN' in Silicon Valley. The 20-year-old personal-computer bull market is dead, and it is high time for technology companies dependent on PCs to shed their denial and start retooling their business models to cope with a new reality.
So says veteran semiconductor capital-equipment analyst Mark FitzGerald of Banc of America Securities, who has been covering the sector for more than a decade. In fact, FitzGerald, who was on The Wall Street Journal's all-star analyst list and Institutional Investor's honor roll each of the past two years, has a number of provocative observations.
"I don't think that all management has caught up with the changes that are washing over the industry right now," he warns. FitzGerald points out that semi-conductor capital equipment companies have been conditioned to eat losses during downturns, in order to preserve capacity needed to capitalize on the huge upturns that would usually follow such troughs. "They would build out a lot of infrastructure during a boom and hold on to it during a downturn," FitzGerald says. "They would suck in their guts and hold on to those expenses; and when the economy came back they would cover those expenses."
That business model worked well for a long time. But now, it will work no more, FitzGerald says. The entire industry is going through a transformation, one that will call for consolidation and one where the survivors will no longer be able to hang on to factories, technology and high-priced talent during cyclical downturns.
"You can't count on PCs anymore to bail you out of the cost structure that you have adopted," FitzGerald says. "Many of these companies have business models that make no sense."
Larger companies will have a distinct advantage in the post-PC era, which is why FitzGerald has picked Applied Materials as a survivor. While that might seem to be a no-brainer, Applied still will have to go through a painful transformation. In March, the Santa Clara-based company announced that it would cut 2,000 jobs, or 14% of its workforce. That followed plans announced in November to cut 1,750 positions. The reductions are expected to be the first in which a large number of senior executives will be shown the door, FitzGerald says.
Several hundred employees, including many in top management, are believed to have already been axed at Applied Materials' operations in Austin, Texas, he says. The Austin American-Statesman reported that 230 jobs were cut in April. A company spokesman confirmed that there were layoffs in Texas but declined to provide a figure.
Nowhere has there been a bigger shakeup than at the top. Last Wednesday, the company's board went outside to find a successor to stalwart Chief Executive Officer James Morgan, who will remain chairman. The directors passed over two inside candidates to name 20-year Intel veteran Michael Splinter president and CEO. "By going outside and getting somebody from the industry, it shows that business as usual will not be the way to move forward at Applied Materials," FitzGerald says.
In introducing his successor last week, Morgan said: "We are entering a new era."
FitzGerald notes that tapping a top executive from Applied's biggest customer, Intel, was smart, showing that the company knows where its bread is buttered. Meeting the needs of the eight largest chipmakers (Intel, Micron, Samsung, IBM, Infineon, Toshiba, Sony and Taiwan Semiconductor) will be a key to success.
"Forty-five cents out of every new dollar spent on [semiconductor capital] equipment is spent by a PC chip company," FitzGerald stresses.
While he predicts that Applied Materials will weather the transition, the analyst says investors must currently pay a "survivor premium," with shares trading at 53 times 2003 earnings estimates. Another one of his picks to survive is KLA-Tencor, a maker of process-control equipment that is trading at 55 times future earnings. On the cusp, he says, are: ASM Lithography, Cymer, Lam Research and Novellus.
Those he deems to have "little hope for survival" are: merchant mask vendors Photronics, DuPont and Photomask; testers Credence, LTX and Teradyne; subsystem vendors Advanced Energy Systems, Helix Tech, MKS Instruments and Mykrolis; automation companies Asyst, Brooks Automation and Newport. And last on his "little hope" list are two ion-implant outfits: Axcelis and Varian.
Of course, all bets are off if the next new thing arrives tomorrow, and is as dependent on silicon as was the personal computer. |
