***UPDATE ON TAIWAN, INVESTMENT OPINION***
Chip Stock Sell-Off is an Overreaction -- Taiwan Quake A Blip in A Powerful
Semiconductor Recovery
______________________________________________________________________________
Key Points
*** The fire sale in chip stocks yesterday is in our view a gross overreaction
to the concerns over the effect the Taiwan earthquake is likely to have on
PC and semiconductor demand in the future. Continued weakness in
semiconductor stocks would comprise the buying opportunity we have been
waiting for.
*** Our checks indicate that the damage to the semiconductor foundries in
Taiwan is minor, and we expect the factories to return to full production
after approximately two weeks of down time for repairs, and equipment and
process requalification. TSMC indicated yesterday that it expects about
85% of power to be restored to its operations by Saturday evening in
Taiwan.*** The effect of a two week shutdown in operations and loss of some
work-in-process is likely to have a material effect on fourth quarter
results for both semiconductor and electronic system companies. However,
we view this effect is strictly temporary, and expect the supply
disruption to be a short term, contained event. We strongly believe the
semiconductor industry will be back at full capacity during the fourth
quarter, and will be completely recovered from the effects of the quake by
the first quarter of 2000.
*** The semiconductor and motherboard supply disruption is a discrete event,
and should have no effect on strong demand for electronic systems and
semiconductors. Although chip companies may have difficulty supplying all
of the products their customers want in Q4, we believe the demand will
remain and be fulfilled during the first half of 2000. Ironically, the
building of strategic inventory to guard against Y2K disruptions, which we
viewed as potential inventory risk next year, could help companies
moderate the impact of the supply disruption in the fourth quarter.
*** Our conviction in the semiconductor industry cyclical recovery remains
strong. Our only concern in recent weeks has been the lofty valuation the
stocks have attained and the risk of a near-term correction in the stocks.
If the stocks continue to sell off due to shortsighted concerns over the
Taiwan disaster, we will certainly re-evaluate our ratings and would
become more aggressive buyers of semiconductor stocks.
TAIWAN QUAKE DAMAGE APPEARS CONTAINED
Our continued checks with our Taiwan colleagues, fabless semiconductor companies
and foundries indicate that the effects of the disastrous earthquake are rapidly
being contained. We believe the wafer plants have sustained no long term
structural damage. Our information indicates that the damage is minor and
limited to relatively superficial issues like broken glassware, cracked or
broken quartz furnace tubes, etc. The greatest delay has been the restoration of
power, which has taken longer than expected but is improving. TSMC indicated in
a press release late yesterday that it expected to have about 85% of power
restored to its wafer plants by Saturday evening in Taiwan (early Saturday
morning in the U.S.). Once power is restored, the foundries can commence with
verifying integrity of gas, chemical, and water lines, diagnosing and re-
qualifying equipment and processes, and ramping production levels. We estimate
these activities to take approximately 7-10 days, resulting in a loss of
production capacity of about 2 weeks.SUPPLY DISRUPTION A DISCRETE EVENT
The overall effect of the earthquake on motherboard and semiconductor supply
will have a substantial impact on output in September and October, with
September the larger impact due to the period of inactivity, and October
affected by scrapped wafers that were already in the production line. Assuming
the factories ramp back to full production capacity by the beginning of October,
the factories will be at full volume output by November. Because the factories
did not sustain any long term damage, the supply disruption will be a finite
event that should be completely recovered well before the end of the year.
Consequently, our optimistic outlook for the semiconductor industry in 2000 is
unchanged.FOURTH QUARTER FINANCIAL RESULTS COULD BE AFFECTED - SO WHAT?
If current inventory levels in the channel and at chip companies are
insufficient to meet fourth quarter demand, fourth quarter shipments for
semiconductors and systems could fall short of plan. The negative impact of the
supply disruption on fourth quarter results could be moderated by inventory
build-up to hedge against post-Y2K supply disruptions, which we believe was
partly responsible for the exceptionally strong semiconductor bookings activity
during the last 60 days. This is somewhat ironic, since we had viewed this
inventory build as a prime risk factor in a post-Y2K inventory correction which
we believed posed a near-term risk to the semiconductor stocks.
It is important to keep in mind that any shortfall in fourth quarter revenue and
earnings results for the semiconductor, sub-system and system companies is a
very short-term event, and is likely to be made up during the first half of
2000. We see no reason why the strong demand for PCs, servers, wireless
handsets, consumer electronics, and broadband communications equipment will
weaken in 2000, and we believe unsatisfied fourth quarter demand will simply
shift into the first two quarters of 2000.
It is important that investors not miss the forest for the trees - in our view,
panic selling of semiconductor stocks due to fears of a fourth quarter shortfall
would be a short-sighted mistake.SEMICONDUCTOR CYCLE REMAINS INTACT
The effect of the supply disruption caused by the earthquake in Taiwan is
temporary, and in no way diminishes our bullishness on the current semiconductor
cyclical recovery, which we believe is in full swing. Semiconductor availability
had substantially tightened during the past few months, evidenced by general
lengthening of lead times, price stabilization/firming, lengthening backlog
visibility, declining turns bookings levels, and other factors. Demand for
semiconductor products is strong, and is growing, and we expect demand trends to
remain positive throughout next year. Investment in new wafer manufacturing
capacity is growing only modestly, and we expect the overall industry supply-
demand balance to tilt toward increased supply constraints in 2000, although we
had expected moderation of the current supply constraints during the first
quarter of 2000 due to normal seasonal slowness in the PC, wireless handset and
consumer electronics markets.
Interestingly, the supply disruption caused by the Taiwan earthquake could have
a stabilizing effect. Supply constraints could limit the amount of system
inventory built in the fourth quarter, minimizing the risk of an inventory
correction in the first half of 2000. Also, shifting of some fourth quarter
shipments into the first half of 2000 could moderate the normal seasonal
slowdown that occurs in the first half of the year. Finally, the exacerbated
supply constraints over the remainder of 1999 could have a marginally positive
effect on semiconductor average selling prices. We see no reason why the tragic
earthquake in Taiwan should compromise the industry recovery or limit it in any
way. If anything, it could actually smooth out some of the seasonal volatility.
STOCK SELL-OFF UNWARRANTED
We think the stock sell-off was probably due to concerns over the impact of the
foundry disruption on fourth quarter semiconductor company results and also
continuing interest rate fears causing broad market weakness. While the interest
rate fears may persist for a while, we think the selling of chip-stocks due to
Taiwan-specific worries is short-sighted and irrational. On the other hand,
nobody ever called the stock market entirely rational.
The question is, now that the selling has started when will it stop? We expect
investors to take advantage of sell-offs such as yesterday's to buy
semiconductor stocks, but we think the stocks are likely to fall further before
finding a true support level. We expect the Taiwan situation to provoke ongoing
controversy, and it has been our belief that many chip stocks had become
somewhat overextended in terms of valuation. We think the Taiwan disaster could
trigger enough uncertainty to cause profit taking and ultimately drive a
substantial correction in the stocks. This is precisely the opportunity we have
been waiting for.CORRECTION WOULD BE A GIFT
If the semiconductor stocks undergo a substantial correction of 15% or more as a
result of the fears ignited by the Taiwan earthquake, we would urge investors to
take advantage of such a gift by aggressively buying a broad portfolio of
semiconductor stocks. We would likely react to a sizeable correction by
upgrading several names that we have viewed as attractive long term investments
but fairly valued in the near term. Our favorite names after yesterday's sell
off are Intel, LSI Logic, National Semiconductor and Triquint. The decline has
increased the attractiveness of stocks such as PMC-Sierra, Altera, Galileo, and
Lattice Semiconductor. We would use the sell off to accumulate these stocks, and
would become more aggressive buyers on additional weakness. |
