Chris:
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By Om Malik
Laying the Internet can be volatile: The portals, content sites and "one-day-we-expect-to-turn-a-profit" online booksellers are too fickle these days. So how can an average investor benefit from the explosive growth of the Internet without running the risk of losing their retirement funds? Investors should look into owning those companies which provide the building blocks that make communication over the Internet possible.
Stocks such as Yahoo! (YHOO), eBay (EBAY) and Lycos (LCOS) have high visibility because most consumers tend to use their services often. However, between that order for the latest John Grisham paperback and your computer screen is a big fat pipe and lots of hardware, through which the information flows.
There are eight semiconductor companies that make components for this infrastructure, also known as the Internet Integrated Circuit (IC) (see table). This group makes the chips that are the workhorses the Internet needs to exist. Content will come and go. The tools that people and companies need to communicate are here to stay.
"This is a group of companies which have a very bright future," says Clark Westmont, networking chip analyst with Nationsbanc Montgomery Securities in San Francisco. "We are in the golden age of networks, and these chip companies will be big winners." These networking chips are growing at a 35%-per-year rate compared with 8% for memory chips (DRAMs).
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"We are in the golden age of networks, and these chip companies will be big winners."
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"Those chip companies targeting their products to Internet infrastructure, datacom, set-top boxes, cable modems and related hardware are expected to see continuing up-trending demand," writes Joseph Osha, a semiconductor analyst at Merrill Lynch in his recent comment on the semiconductor sector. His recommendations include Vitesse (VTSS), PMC Sierra (PMCS) and Broadcom (BRCM).
How should investors look at the fundamentals of these companies? Typically, in semiconductor stocks, investors can feel comfortable if the price-to-earnings ratio is equal to or less than the sales growth rate. Anything higher increases the downside risk in chip stocks. Investors should also look for companies that have a considerable market share. They do not have to be market dominators like Intel, but a 30% or higher market share is impressive. An Internet IC is a very complex piece of silicon and the group of eight companies we have short-listed have defensible positions in the industry.
"My approach is to try and find positive business momentums," says Merrill Lynch's Osha. BancBoston Robertson Stephens' communications chips analyst Elias Moosa could not agree more. "I like PMC-Sierra, and Vitesse because they have the products which make the key new bandwidth technologies like SONET and ATM possible," he says. SONET stands for Synchronous Optical Network, while ATM means Asynchronous Transfer Mode, two types of technologies that help transfer data and voice over the networks.
To understand how important these chips are to the growth of the Internet, consider the way Tom Hanks and Meg Ryan communicated in the movie You've Got Mail.
Hanks writes Meg a short note on his AOL E-mail software and hits the send button. The message is then diced into small bits of data. Those bits of data are then sent to a network interface card (NIC) where commodity-type chips from companies such as National Semiconductor (NSM) or Cirrus Logic (CRUS) direct the bits to Hanks' internal local area network (LAN). (Do not rush out to buy shares of National Semiconductor or Cirrus.)
Hanks' E-mail then zips across the LAN at ten megabits per second, to a fast Ethernet switch. At this point, it will pass through the chips of companies like Galileo Technologies (GALTF) or Level One Communications (LEVL). Investors should look at these companies, says Clark Westmont, the networking chip analyst with NationsBanc Montgomery Securities in San Francisco.
Westmont is bullish on Level One because it has a larger number of customers who buy many different types of products from the company. He thinks that the stock can trade at 40 times fiscal 1999 earnings of $1.22 a share. "Level One has grown at a rate of 40% or more for the past couple of years, and they command a multiple which is in line with their growth," he adds. He also likes Galileo. (See table for financial details.)
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