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Chips: Gloom to Zoom -- and Back Again

When the Semiconductor Industry Assn. predicted on June 5 that worldwide chip sales will grow 3%, to $141 billion in 2002, investors breathed easier. After a 31% sales plunge in 2001, even a modest growth forecast from the respected trade group sounded good enough to boost most chips stocks.

Two days later, Wall Street was grabbing for oxygen masks as stocks took a sickening dive on news from giant chipmaker Intel (INTC). It reported that demand for its advanced microprocessors, which was growing nicely last quarter, had wilted faster than cut flowers on a hot summer day. Revenues would fall below expectations, it declared. Said a disappointed Andy D. Bryant, Intel's chief financial officer: "We were just counting on a little pickup across the board."

Join the club. The chip business was supposed to take a turn for the better in the second half. Market researchers such as International Data Corp (IDC) and In-Stat/MDR were calling for healthy sales increases for everything from microprocessors to memory to analog chips for cellular phones and autos, even through early June. So were many Wall Street analysts, who had predicted strong back-to-school buying and increasing corporate upgrades of aging technology. But that's hard to reconcile with the ongoing litany of tech companies spouting downward sales revisions.

NOKIA'S WOES. After posting decent sales in the first three months of the year, purchases of desktop PCs, handheld computers, and other gadgets that use lots of chips have slowed to a crawl. Hewlett-Packard (HPQ), Sony, and other PC makers say consumer demand is weakening, while corporate customers continue to sit on the sidelines (see BW Online, 6/7/02, "The Forces Conspiring Against PC Sales"). The latest blow: Cell-phone giant Nokia (NOK) predicted on June 11 that second-quarter sales would slump because of slower-than-expected demand for its handsets.

The gloom has now engulfed chipmakers, who are grappling with increasing inventories and decreasing profit margins. And the stock market is sharing their pain. The PHLX Semiconductor Sector (SOX), an index of 17 U.S. chip stocks, soared in May amid expectations of a second-half demand-driven resurgence. The index has plummeted about 10% since Intel's announcement. The giant's stock has fallen from near $30 a share before its announcement and is now bumping along closer to $20. Advanced Micro Devices (AMD), Micron Technology (MU), Texas Instruments (TXN), LSI Logic (LSI), and most other major players are looking equally battered.

Why the sudden disconnect, after the great expectations for a recovery in the second half? Many companies apparently misinterpreted strong demand for chips early in the year. Brisk sales in the first quarter, according to research from Merrill Lynch, reflected inventory replenishment by PC and handset makers. That's over.

ROUGH ROAD. And if there were any hopes that the trend would be followed by increasing corporate and consumer spending, they have now been dashed. "This market doesn't have any shock absorbers for surprises, and we're getting plenty," says Merrill Lynch analyst Joseph Osha, who downgraded chip-sector prospects on the Intel announcement.

Pockets of sunlight do exist. Texas Instruments CEO Thomas J. Engibous says TI is seeing strong demand for chips destined for consumer-electronic devices, such as digital cameras and MP3 players, wireless Internet home networks, and next-generation cellular phones. Liquid-crystal display screens, automobiles, and handheld gizmos suck up millions of chips every month -- and should continue to do so. Cellular handsets alone will consume about $14 billion worth of chips this year, according to In-Stat, roughly equal to last year.

Still, when Intel talks, Wall Street listens. Last year, the chipmaker accounted for nearly 18% of the world's total $139 billion in semiconductor sales. So Intel's disposition can be a reliable signal of consumer and corporate demand worldwide. In his midquarter update, CFO Bryant warned that early PC shipments for the back-to-school season have failed to materialize. On the corporate side, Intel's crystal ball is still murky. And with the unending string of corporate-governance and accounting problems eroding already-shaky business confidence, IDC analyst Roger Kay thinks technology managers could continue to hold purse strings tight.

WATCHING AND WAITING. Through it all, the Semiconductor Industry Assn. seems curiously out of sync with Intel. In its June 5 report, the organization predicted a 14% jump in microprocessor sales this year -- a number that other analysts and market watchers find baffling. Indeed, In-Stat reports that chip sales through April were well below last year's already weak figures because of lower average selling prices.

Investors seem to be siding with Intel, at least until they see stronger demand for end products that use chips. When will that be? As any losing team will tell you: There's always next year. By Cliff Edwards in San Mateo, Calif.

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