Green...This is how the bottom looks like...
From Barron's APRIL 16, 2001
Semi True
By Alan Abelson
Smith & Wollensky. Name ring a bell? No, they're not hedge-fund managers, though the hedge-fund gang and almost every variety of investment professional eagerly line up to give their orders to the pair. And both of them are unabashedly bullish, Wollensky maybe a little more so.
Smith & Wollensky are in the business of giving eats to mostly chubby men with ravenous appetites and diamond-studded rings on their fat pinkies, and whose ranks are thickly populated by Wall Street types. (Women, of course, are more than welcome, provided they are of sufficient amplitude.)
Now, normally, the Messrs. Smith & Wollensky are market-neutral, since you never know when a pack of bears might reserve a couple of tables. But apparently, they've spotted a bottom so compelling that they've abandoned their normal noncommittal stance and, as intimated, have turned salivatingly bullish.
Not, understand, that they've done anything so crude as to list on their menu, along with the humongous steaks, succulent chops and massive lobsters, a choice of mouthwatering stocks to buy. Rather, along with a number of other restaurateurs -- most of whom, like S&W, cater more to gourmands than gourmets -- they've announced that henceforth the price of a three-course lunch on Fridays will be pegged to the Nasdaq close the day before. Last Thursday, for example, Nasdaq closed at 1961, so Friday's lunch would be ticketed at $20. (This crew can't help rounding figures.)
Well, after we digested the concept, it struck us that such savvy fellows with as much inside info as Smith & Wollensky, or counterparts like Maloney & Porcelli, would never have taken such a bold step if they weren't absolutely convinced which way Nasdaq was headed. We mean, they're not in the business of lowering prices every Friday.
Only a dyspeptic cynic would conjecture that their implicit forecast reflects a kind of desperate hope, inspired by stomach-churning visions of what a bear market will do to the expense accounts that so beef up their bottom lines.
But recent market action, and particularly last week's, strongly suggests that the victual purveyors can time a rally with the same finesse they do a sirloin rare. So we gladly add to our analytical arsenal the brand new Smith & Wollensky Indicator, and advise that you keep an eye out and an ear cocked for a sell signal when S&W take their generous offer off the table.
For, alas, it's a foregone conclusion that they're destined to do so. That stocks, especially the techs, rallied surprised no one, not even us. In view of the tremendous pounding that Nasdaq in particular had absorbed, the only questions were when the bounce would come and how big it would be.
The answers, respectively, are: "It's come" and "We'll see."
However long and far it carries, because its impetus is reflexive rather than substantive, the rally is destined to be overwhelmed by the powerful pull of plunging profits and deepening recession. One of those things, in other words, that, like a great meal, for all you savor it, doesn't last.
Nothing, perhaps, better illustrates how vaporous is the stuff powering this rally than the charge provided by the chip stocks. On the incredibly brilliant insight of a leading analyst that the semis are so far down it feels like up, the group, with Micron in the lead, took off, in the process igniting interest in a motley band of techs.
Such inanity deserves no mercy and, happily, received none from an astute Boston investment research outfit named Fechtor Detwiler. Thursday morning, in barely more than a page, it did a very neat demolition job on the new received wisdom in the Street that recovery is just around the corner for the semiconductor makers and happy days are here again for their stocks.
"So this is what a bottom looks like," the report begins, with sardonic innocence. It then goes on to lament that bottoms are all in the eye of the beholder: "What constitutes a bottom for analysts and investors isn't the same for people whose livelihood is dependent on the strength of the semiconductor market."
The notion suddenly so popular in Wall Street that the absence of any bookings means things can only get better, for some reason, the firm reports, has utterly failed to reassure the sales reps and distributors who peddle the semis and have been wrestling with a "bigger issue than an inventory overhang." And, wouldn't you know, someone plumb forgot to inform folks in the chip business that pricing pressure has been eliminated.
If only those poor souls on the front lines and in the back offices of the industry were privy to the same intelligence as securities analysts, their brows would wondrously come unfurrowed and their sagging spirits take wing.
Fechtor Detwiler and the lads and lassies who labor for them manifestly are afflicted by three serious handicaps. The first is a compulsion to check in with, even -- horrors! -- mingle with, the grunts in the trenches. The second is a thorough familiarity with the field they're covering. And the third, a truly serious handicap, is an ability to combine observation and information to formulate a logical conclusion.
In its dispatch, the firm reminds us that the seeming stability of the gross margins of the semiconductor makers is rather deceptive in that it's the paradoxical result of the continued stream of cancellations and returns by chip customers. "If Cisco's trying to send components back to distribution/suppliers," Fechtor Detwiler points out, it's not exactly in a great position to dictate pricing. However, that's sure to change as those customers -- a/k/a original-equipment makers whose corporate shelves are groaning with chips -- whittle down their inventory.
The semi cycle, FD (forgive the familiarity, but it saves finger-wear) asserts, has two legs. The first takes the form of excess inventory; the second, severe pricing pressure. "We believe this second shoe is just getting laced up and is going to wreak havoc" on not only the industry's "revenue but also margins."
In some semiconductor areas, havoc already is being wreaked. MOSFETs, for example. The acronym, we're sure you're dying to learn, stands for metal oxide silicon field effect transistor, and it's a dandy little gizmo that, in effect, is a versatile and otherwise much advanced semiconductor version of the old electromechanical relay.
Dandy it may be, but makers of this power device are feeling the heat. For instance, Fechtor Detwiler reports, citing electronic-component distributors Arrow and Avnet, a company called STMicroelectronics "has offered to beat any competitor's price and guarantee a 30% margin to the distributor." That, FD drily comments, "is surely not going to help the margins at ON Semiconductor, International Rectifier, Fairchild and Toshiba."
The cruel truth is that the increasingly hard-pressed customers for chips of all kinds soon will be turning the meanies in their purchasing departments loose with orders to squeeze every supplier in sight. Especially bad news for the semi companies that grew rich and sassy supplying communication-equipment makers and have the rotten luck to be low men on the totem pole.
For the pain travels down the purchasing chain. To wit: The original makers of communication equipment reaped riches galore from what FD calls the "open checkbook" policies of such customers as the dot.coms, the established phone companies and the curious mutations known as CLECs (competitive local exchange carriers) and ASPs (not the venomous reptile, although shareholders might dispute that).
But now that the boom's gone bust, FD comments, and "these guys need to start showing a profit and must justify the return on investment for new hardware purchases, they're coming down hard" on the communication original-equipment makers. How hard? Well, "Sycamore, Cisco, Nortel, Lucent, Tellium, Cabletron and others" have gotten the word from their broadband-carrier customers that prices have to be shaved some 40%, or they needn't bother wasting their breath asking for new orders.
So, what do Sycamore, Cisco, Nortel, Lucent et al. do in response? Simple: They tug their corporate forelocks and then turn around and put the squeeze on their suppliers, most conspicuously including the chipmakers.
As Fechtor Detwiler relates, "Cabletron cordially invited its top 25 suppliers in this week in order to demand 40% price concessions." The problem, alas, is that most of the suppliers "don't have a spare 40% to give up and remain profitable, not to mention achieve double-digit growth rates."
As further evidence of how removed Wall Street is from the way things are in the semiconductor business, the firm cites the industry's mounting layoff toll and muses, "Could the semi companies be getting it all wrong? Aren't they going to miss the rebound scheduled to begin sometime this summer?" Well, apparently, news of the recovery hasn't yet made the rounds.
AVX, for instance, is "reportedly set to announce substantial layoffs (supposedly 22% of its workforce). There's talk in the trade, too, of "more Cisco pink slips, which could be passed out as early as Monday." And, adds FD, the recent IPO Agere Systems "is said to have quietly dismissed 250 employees at its Orlando facilities."
Finally, Fechtor, Detwiler insists that the semiconductor bulls don't seem to have a clue as to just how much excess inventory remains to be liquidated. Cisco, just by way of example, is still supposedly "struggling with absurd levels of finished-goods inventory," while its component inventory, the story is, runs a formidable $1.2 billion. Not especially encouraging for suppliers like chip makers, since the company is in the throes "of cutting weak programs and aggressively designing next-generation systems."
That prodigious pile of inventory, FD says, "may help explain why contract-manufacturing friends of ours are telling us that ... Cisco and its electronic-manufacturing-services-channel partners will be unloading some $800 million worth of excess DRAM inventory into the broker channel as early as next week…"
Why do we have the feeling that the threat of such a monstrous dumping of DRAMs onto a limp market might not have fully registered on last week's hot and heavy buyers of Micron Technology? Keep in mind that Micron, according to FD, "will do approximately" $800 million in revenues this quarter, and the firm's DRAM contacts confide that "demand is nonexistent."
In brief, on closer inspection, that "bottom" in semiconductors appears nothing more than an optical illusion, a dreadful side effect, no doubt, of going so long without even a morsel of good news. Fechtor, Detwiler relays the sentiment of its distributor sources that, grim as the first quarter was, the second quarter will "most certainly be worse."
A retreating tide lowers all boats. We're aware that isn't the usual construction, but right now it seems a heck of lot more pertinent as an economic metaphor. What emerges from the foregoing damage report on the semiconductor business, besides the obvious conclusion that the companies in it are not exactly in the chips, is further confirmation that the slump in technology has spared no one, not even mighty Cisco.
And we suspect, despite a solid first-showing, it won't spare Cisco's rival router-maker Juniper Networks. Calling earlier expectations for this year a bit too exuberant, the company projected earnings for all of '01 at 90 cents to $1 (up from 43 cents last year).
Juniper's a good company, has been taking market share from Cisco, and the stock's down from above 244 to 50 (it jumped seven bucks on Friday on the earnings report).
Trouble is, though, it's dog-eat-dog time in telecommunications and Juniper hasn't been around long enough to really tell how it'll fare in so hostile an environment.
Even though it's way down from its peak, the stock still sells at 50 times estimated earnings, a multiple that scarcely discounts the possible -- we'd say, likely -- negatives. |
