Dot com shakes in silicon cycle

Profits are sagging for some high-tech firms but analysts say the chips are not yet down, writes SAEED
SHAH

When Jonathan Joseph, a California investment analyst with Salomon Smith Barney, reduced his stand from "outperform" to "neutral" on the semi-conductor industry in July, he apparently received death threats.

It is not as if he even said "sell," but he did point to signs of declining chip shipments, falling prices, a slowing of mobile phone growth and a peaking of capital spending by chip-makers.

In Silicon Valley, calling the top of the silicon cycle is no laughing matter. Jobs and investment depend on the microprocessor industry, and in San Francisco suburbs, belief in its potential for unlimited growth is unshakeable.

It is easy to see why the dot com bubble burst in the Northern Hemisphere spring. Many of these companies had no discernible revenue model, let alone a route to profit. Sooner or later, even brokerages pushing these stocks had to own up - these emperors had no clothes.

But the technology industry is real, making real products, with many of its biggest companies enjoying big margins and pulling in billions of dollars a year in revenue.

The semi-conductor industry has had an average yearly growth rate of 18 per cent for the past 30 years, driven by what, all those years ago, would have seemed incredible advances in the processing power of chips. Much personal and corporate wealth in America is tied to the fortunes of the likes of Cisco and Intel.

So is the industry heading for a downturn? Commentators fret, with good cause, about the ability of fixed-line telecom companies to finance the cost of laying fast new networks to carry internet traffic. They also question the ability of mobile phone service providers to pay for the huge cost of "third generation" licences, which will allow them to run the networks of the future.

We have seen a spate of profit warnings from many of those seen as high-tech superstars, including Lucent, the telecoms equipment company, Dell and Apple, the computer manufacturers, and Motorola, the mobile phone and chip-maker.

Most significant was a profits warning from Intel, the microchip behemoth whose processors are used in more than 80 per cent of the world's personal computers.

When Intel said that weaker than expected demand for PCs in Europe meant third-quarter sales would fall short of forecasts, the statement resonated around world markets and wiped $US91 billion ($228.6 billion) off its value in one day. Technology stocks, from Cisco to Microsoft, suffered with it.

Mr Joseph's startling market call appeared to be coming true even faster than he had anticipated. With Nasdaq now off about one-third since the euphoria of March, some are starting to believe we are staring at the abyss.

But the prophets of doom do not have it all their own way. The semiconductor industry is extremely cyclical and it is supposed to be in the middle of a boom. From 1996 to 1998, the sector was in a slump, caused by oversupply and sluggish demand, compounded by the Asian financial crisis. In 1999, the market picked up.

Technology research firm Gartner Dataquest believes sales in the semi-conductor industry will grow this year by 37 per cent, to $US232 billion. It does not forecast a downturn until late 2002.

And Andrew Griffen, an analyst at Merrill Lynch, said the pattern of industry's cycles did not point to a significant slowdown soon.

"Three years of above-trend growth caused the last downturn," he said. "We have had very rapid growth this year, but it is the first year in five with above-trend growth. It's a catch-up year. We are not in a crazy oversupply situation."

Some companies support this, including Sony and Ericsson, which have not been able to get hold of sufficient supplies of chips. In Britain, Pace Microsystems said it was frustrated by a shortage of the flash-memory chips it needs to make its digital television set-top decoder boxes.

Although a few technology firms are not performing up to the demanding standards they set for themselves, competitors are booming.

Advanced Micro Devices (AMD), Intel's biggest rival, beat forecasts with the news that third-quarter sales had jumped 82 per cent.

AMD is focused on the home PC market, which has not slowed as much as the corporate and education markets.

To some extent, Intel has found itself in the wrong market. PCs are becoming yesterday's news. The juicy pickings are now in the high-growth markets of communications, servers and networking.

Andrew Norwood, senior analyst at Gartner Dataquest, does not agree that the chip industry has broken out of its cycle. "In 1995, they said it was the end of the silicon cycle and look what happened," he said. "This industry never learns. Everyone wants 20 per cent market share. When you have 20 companies chasing that, you get overcapacity."

Merrill Lynch's Andrew Griffen said: "What will the global economy do in 2001? Will there be a soft landing? That's where the danger for the industry comes from. If there's a big economic slowdown, people may not change their cellphone so often.

"I'm a silicon industry analyst. People ring me to ask where we are in the silicon cycle and if there's going to be a downturn. But they're asking the wrong person. I tell them they must ask an economist."

- INDEPENDENT