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Chip makers slammed
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November 28, 2000: 4:26 p.m. ET
Broadcom, PMC-Sierra fall for second day on inventory concerns
by Staff Writer David Kleinbard
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NEW YORK (CNNfn) - The makers of semiconductors used for the high-speed transmission of data – until recently among the most high-flying companies on Nasdaq – were socked for a second day in a row amid investors' concerns about a slowing of demand for their products.
As recently as late October, investors seemed to believe that no price was too high to pay for the stocks of companies that make chips used in cable modems, DSL equipment, mobile communications, or optical networking. Communications chip giant Broadcom (BRCM: Research, Estimates), for example, sold for 227 times what analysts expect the company to earn this year.
In early November the bubble burst for the communications chip makers, however, as investors began to realize that their revenue growth in the first nine months of the year had been artificially boosted by inventory buildups by end users. Makers of networking equipment, such as Cisco, Lucent, and Nortel, had purchased all the communications chips they could find, fearing supply shortages. When those supply shortages never materialized, they stopped stockpiling inventory.
"Most communications chip companies have grown two to three times their sustainable growth rate over the past few quarters because everyone was building up inventories," said SG Cowen analyst Rick Billy. "There was a shortage mentality, and suddenly everyone is beginning to say there is no shortage anymore, so I don't have to over-order."
The decline of the communications chip makers – including Integrated Device Technology (IDTI: Research, Estimates), Xilinx (XLNX: Research, Estimates), Altera (ALTR: Research, Estimates), PMC-Sierra (PMCS: Research, Estimates), and Applied Micro Circuits (AMCC: Research, Estimates) – was accelerated by Cisco Systems' disclosure on Nov. 6 of a substantial increase in its raw materials inventories. When Cisco reported its fiscal first-quarter earnings, it disclosed that its raw materials inventory rose 335 percent from the fiscal fourth quarter, from $145 million to $631 million, sending the communications chip makers tumbling the next day.
Stocks hit by Merrill, Salomon Smith Barney
Stocks in the sector were hit again on Nov. 16, when Merrill Lynch analyst Joe Osha downgraded several of them to "accumulate," citing inventory buildup concerns.
"In the best-case scenario, an inventory correction would lead to the communications integrated-circuit sector just making consensus estimates, breaking with the precedent set over the past six quarters and not raising forward expectations," Osha said earlier this month. "Even this, we believe, would negatively impact the stocks in this segment."
"While many of the stocks in this group are already down by 50 percent over the past several weeks, we believe that inventory concerns, coupled with telecom service-provider capital-spending concerns, will weigh on the group for the next one to two quarters," Osha added. "We note that the group in aggregate still has the highest valuations in the semiconductor business, even after the recent decline."
SG Cowen's Billy shares Osha's concerns about high valuations among companies in the group.
"Relative to where the stocks were earlier this year and the expectations people had for growth, some correction was necessary," Billy said. "Their valuations were as lofty as I have ever seen in 20 years of following the semiconductor industry. They were truly off the charts."
The group took a third hit Monday, after Salomon Smith Barney analyst Clark Westmont slashed his price target on Broadcom to $200 from $300, citing "signs of flattening orders in Broadcom's supply chain, inventory concerns in the digital cable sector, and overall valuation compression in the communications IC arena."
Broadcom plunged $19.56 to $97.56 in response to Westmont's comments. At that price, Broadcom was down 57 percent from its close in late October, shedding $30.4 billion of market value along the way. In late-afternoon trading Tuesday, Broadcom was down an additional $11.56 to $86, a loss of 11.8 percent. At the same time, PMC-Sierra was down $6.44 at $96.25, placing the stock 63 percent below its 52-week high of $255.
Salomon Smith Barney's research team in Asia found that there has been a weakening in demand for wireline communications integrated circuits, including networking and programmable logic chips, which are made by Altera and Xilinx. At the same time, AT&T informed several cable infrastructure equipment companies last week that it would be slowing or stopping its new equipment orders for the rest of the year.
Long-term outlook remains strong
While the outlook for communications chip makers over the next few weeks is cloudy, they will benefit from very strong demand over the next several years, analysts say. Analysts have kept their earnings estimates for 2000 and 2001 largely unchanged. What's different now is their view of the appropriate price-earnings multiple to assign to these stocks. The 227 times earnings that investors paid for Broadcom just a few weeks ago now seems absurdly high.
"PMC-Sierra has a business outlook that is undiminished from what it was six to nine months ago," said SG Cowen's Billy. "I believe PMC can grow its revenue 40-50 percent in each of the next three years. We are getting to the point where there are some compelling values out there. If you look out 18 months, I think investors in this sector will do well."
"We continue to believe that Broadcom is extraordinarily well positioned in some of the fastest growth markets in technology," said Salomon Smith Barney's Westmont.
PMC-Sierra, based in Campbell, Calif., had revenue of $462.6 million in the first nine months of this year and reported net income of $124.8 million, or 70 cents per share, over the same period. Revenue for the first nine months of the year was up 128 percent from the same period in 1999, while net income was 228 percent higher. SG Cowen estimates the company's earnings per share will reach $1.65 in 2001, up from an estimated $1.03 per share this year.
Broadcom, based in Irvine, Calif., said earlier this month that it is comfortable with analysts' earnings and revenue forecast for its fourth quarter. Those forecasts call for Broadcom's revenue to rise 125 percent over the same period last year to $368 million and for its earnings to reach 31 cents per share, versus 16 cents in the comparable period last year. The company's growth is being driven by continued brisk demand for television set-top boxes, cable modems, and enterprise networking equipment. 
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