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Applied Micro's macro problem
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November 8, 2001: 5:12 p.m. ET
Even if you believe Applied Micro is a survivor because of its winning technology, the price is dear and the outlook uncertain.
Adam Lashinsky
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SAN DIEGO (CNNmoney) - Applied Micro Circuits CEO David Rickey has an unfortunately apt metaphor to describe his company's plight. It's like a Ewing nightmare, he says, recalling the painfully bad season the iconic television drama "Dallas" tried to write off by having a character pretend a year's worth of episodes had simply been a bad dream.
The numbers tell why Rickey, whose company sells semiconductors to manufacturers of telecommunications equipment, would prefer to wake up again in 2000. Applied Micro's sales for the year that ended last March were $436 million; Applied Micro (AMCC: down $0.45 to $12.05, Research, Estimates) and its Wall Street analysts forecast fiscal 2002 sales of about $165 million. "We just shipped this year's [products] a year early," quips Rickey.
That's cute, but not good enough. Left unaddressed is whether Applied Micro's sales will ever get back to a level that justifies its still-lofty valuation. At around $3.6 billion in value, unprofitable Applied Micro trades at Thursday's closing price of $12.05 for about 22 times forecasted current-year sales. In comparison, industry leader and still profitable Intel -- which is threatening to become an Applied Micro competitor in networking chips -- is valued at about seven times expected 2001 sales.
Indeed, in a speech to investors at the American Electronics Association's annual financial conference in Applied Micro's hometown this week, Rickey made a startling admission. If his newly reduced assumptions of the size of the market for selling communications chips is wrong, he says, then Applied Micro's diminished valuation is way too high. (Its 52-week peak, back in January, was $88.25.) And there's every reason to believe Rickey, like others in the semiconductor and telecommunications industries, has no clue what the market will look like. Just a year ago Rickey was predicting the "total available market" (one of those quaint metric relics from yesteryear) for the communications chip business would be $10 billion in 2005. The figure could be as low as $3 billion now, he says. Rickey also figured the industry's inventory correction would be over by now, and he acknowledges he was early by about a year. Why would his latest market forecast prove to be any less optimistic?
Meantime, though Applied Micro has more than $1 billion in cash, it's bleeding money. Its quarterly breakeven point for expenses is about $80 million but quarterly revenues are in the low $40 million range. So even if you believe Applied Micro is a survivor because of its winning technology, the price is dear and the outlook is uncertain.
"It's a question of timing and what you want to pay for it," says Paul Brandeis, a chip analyst with Needham & Co. who rates Applied Micro a hold. Brandeis notes that Rickey believes Applied Micro's gross margins will return to the 75 percent range despite having plunged below 60 percent last quarter. Margins will be pinched because just as there has been consolidation in Applied Micro's end markets, the telecommunications carriers, there ultimately will be consolidation among Applied Micro's supplier competitors. Translation: Price pressure is inevitable. As a result, Brandeis models the company's long-term gross margins at around 65 percent. If he's right, then CEO Rickey's revenue and expense estimates are too high and will need to come down.
With his stock already off 85 percent from its highs, a reduction in seemingly tempered assumptions will prove even more nightmarish for Applied Micro's Rickey. 
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