Some interesting reading...
from briefing.com:
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Processor v. Bandwidth
There is a paradigm shift underway in technology from processor speed to bandwidth. You might say that this shift is already clich‚, but you can also say that respecting it could have paid off handsomely in the market. Chips are out and telecommunications services and equipment are in.
Factors Behind The Shift
When we talk about processor speed, Intel is obviously the first company that comes to mind, but this story does not end with Intel. It extends to the entire semiconductor sector, the semi-equipment companies, and even has parallels in the disk drive sector. Some of the themes that are relevant in all of these sectors are as follows.
Lack of software upgrades to spur demand for hardware upgrades.
Commoditization of products.
Oversupply.
Pricing pressure due to Asian crisis.
Demand weakness due to Asian crisis.
The Intel Story
Though the story doesn't end with Intel, Intel best exemplifies the problems afflicting all of these sectors. Their average selling price is declining because the demand for processor speed is declining. This is not to say that unit demand for chips is falling; it will in fact be increasing for years to come. But we have crossed a line where unit volume is not increasing enough to offset declining prices.
In the old paradigm, consumers and businesses would be paying top dollar for the Pentium II 400 chip and Intel's revenues and earnings would be
soaring. In the new paradigm, demand growth is the strongest at the low end: PII 200-300, a segment of the market for which Intel no longer has pricing
power. AMD and NSM are now determining pricing in this market segment. This shift is the difference between increasing revenues/earnings and
decreasing revenues/earnings for Intel.
Forget Merced. The delay of this chip is not why Intel has fallen from over $100 last August to under $70 now. Merced will still arrive and it will still generate substantial revenues, but it will not return us to the old paradigm. Yes, Intel is a great company, but semiconductors are not a great business.
Why own a great company in a bad sector when you can own a great company in a great sector?
1,000 Words
Let's move beyond why you shouldn't buy Intel, or semiconductors, or semi-equipment, or disk drives, and talk about what is worth owning. This is the flip side of our paradigm shift: who benefits from the bandwidth revolution? The obvious place to look is telecommunications services and equipment. Find a great company in this sector and you will have a great company in a great sector. The chart comparing the stock prices of Intel and Lucent since the beginning of 1997 highlights this point (both stocks are set to an index of 100 in 1997). With Intel, you've had dead money; with Lucent, you've more than tripled your investment.
The Telecom Story
Telecommunications is not the Answer with a capital A, largely because the latter two factors noted as problems for semi and semi-equipment companies are also factors for many telecom companies, namely Asia (pricing pressure) and Asia (demand weakness). Thirteen telecom equipment companies had earnings warnings in Q1, and six of these specifically mentioned Asia as a factor.
Telecoms equipment and services are therefore the answer with a lower case a. This will be a winning sector in coming years, but many companies are at substantial risk of missing estimates over the near term due to Asia. The best approach to this sector is to draw up two lists, a near-term buy list for companies with insignificant Asian exposure, and a future buy list for good companies that face substantial near term challenges related to Asia.
In addition to looking for some protection from Asia, we also look for a diverse product line. You can hit some home runs in the telecom sector with niche players, but you will be a Dave Kingman-type hitter -- a lot more strike-outs than HRs. The diversified players offer much less risk but still hold huge upside potential. We'll break them down into equipment and services. First, equipment.
Lucent (LU): You saw the chart above -- this is the great company in the great industry. Great management, diverse product line, and not much Asian exposure.
Cisco (CSCO): Call them a networker, call them a telecom equipment company, call them whatever you want, but also call them a beneficiary of the bandwidth revolution, a company led by a CEO (John Chambers) who is one of the best, and a company that will never fall behind the technology curve (what they don't have, they'll buy).
Tellabs (TLAB): Not as well known as LU and CSCO, but here's a company with a dominant position in the digital cross-connect market and huge upside potential in the voice/data over Cable TV market and, best of all, no Asian exposure.
Nortel (NT): We'd pick the other three first, but here is another diversified telecom equipment pick with little Asian exposure.
Here are some ideas in the telecom services sector. Our criteria in this industry once again include limited Asian exposure, but the other key is a focus on data communication over voice communication.
Qwest (QWST): With no investment in an existing (read: obsolete) network, Qwest is building a top of the line fiber network from scratch and they have the best management in the industry, led by CEO Joseph Nacchio, formerly of AT&T.
Worldcom (WCOM): Even without MCI's Internet division, WCOM will be a global leader in data communications with its UUNet division.
Aside from these picks are some compelling companies that carry just a bit too much Asian risk for our tastes. When Asia shows signs of turning the corner, these companies will be worth a closer look.
Advanced Fibre Communications (AFCI): Stock has been struggling a bit recently, and exposure in China will be a significant drag if there is a yuan devaluation, but its UMC product has been dominant in the US market.
ADC Telecommunications (ADCT): Stock was pummelled after announcing it would miss Q1 earnings, but has come rebounded a bit after beating its Q2 number. ADCT has significant international exposure, but is worth a look once Asia settles.
The Right Side of the Paradigm
The whole tech sector has been trading poorly of late, and the correction has probably not played out yet, making all of the stocks mentioned here risky near-term propositions. In another year or two, however, we expect that the graph of Intel and Lucent for mid-1998 to 1999 will look very similar to the 1997 to mid-1998 graph, and that you could say the same of most any graph comparing a semi or semi-equipment stock to a Lucent, Cisco, Tellabs, Qwest, or Worldcom. The paradigm shift is a clich‚, but it's also true.
Parting Shots
It's been warnings season for a few weeks, but so far, those warning have been mostly small-cap players who badly missed their quarter. Now, it's time for the big leagues. Intel, Motorola, and Compaq warned on March 4, 5, and 6. The corresponding dates this quarter would be this Wednesday through Friday -- don't be surprised by one or two big-name tech warnings. Intel already guided Q2 numbers lower with their Q1 report, but we wouldn't rule out an additional warning given the lousy pricing environment for low-end chips.
Warnings scorecard: 11 tech companies warned in the first two weeks of the Q2 warnings season versus just four in the comparable Q1 period.
This week is already off to a bad start, with four tech companies warning on Monday alone versus seven for the entire comparable week in Q1.
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