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Chipmakers Face a Chilly Fall

By Arik Hesseldahl Concerns over falling prices in the computer industry flared last month, when PC-market leader Dell conceded that it had slashed prices too far (see BW Online, 8/25/05, "What's with the Dell Doldrums?"). The cuts forced it to miss its sales forecast and lower projections for the current period.

More evidence of pressure came earlier this month, when the Semiconductor Industry Assn. said July computer-chip sales slipped to $18.01 billion from a year earlier. The culprit? "Strong competition" drove down prices for chips, SIA President Scalise said at the time.

Hopes for a let-up in pricing pressure may get dashed on Sept. 8, when chipmaking giants Intel (INTC) and Texas Instruments (TXN) update investors on expectations for the current quarter.

DROPPING POINTS. As Dell (DELL) and other PC makers, including Hewlett-Packard (HPQ), cut prices to lure back-to-school shoppers, they're haggling for better deals on chips. Ditto for handset makers such as Motorola (MOT) and Nokia (NOK), which are among TI's biggest customers.

"Dell's results demonstrated that the industry is in a phase of being unit-rich but revenue-poor," says Ashok Kumar, an analyst at Raymond James & Associates. "This isn't only specific to the PC industry but will also be apparent in handsets and in emerging markets as well. Price points will continue to drop."

Adding to Intel's woes, rival Advanced Micro Devices (AMD) is forcing Intel to push down prices on its Xeon chips for servers, the computers that run Web sites and corporate data networks, notes JPMorgan analyst Chris Danely. Intel may tighten its revenue forecast to between $9.8 billion and $10 billion for the fiscal third quarter and maintain its forecast for gross margin, a yardstick of profit, of about 60%, Danely says. Intel now expects revenue to come in between $9.6 billion and $10.2 billion.

HANDSET HANGUP. Intel's outlook on chips used in desktop computers may not be rosy either, says Michael McConnel, an analyst at Pacific Crest Securities in Portland, Ore. "Right now, demand is healthy, but we're seeing some signs of an adverse mix in PC products," he says. "Intel has been very supply-constrained on PC chipsets," McConnel adds, referring to the chips that sit between the microprocessor and other subsystems in the computer. "And I have to wonder if that's going to have an effect on desktop-processor shipments."

Profit margins are also under attack at Altera (ALTR), but for different reasons. Altera, in a mid-quarter update this week, cut its margin forecast, saying sales of programmable chips used in communications gear were slower than expected. The company lowered its profit-margin forecast to 66%, from 67%, sending the stock into a tailspin. It closed at $20.11 on Sept. 7, down $1.69, or more than 7%, from the previous close. JP Morgan's Danely says Altera's lowered research and development expenses and reduced costs for masks and wafers used to make chips would offset lower gross margins into 2006.

The trade-off between surging unit sales and slipping prices is hitting wireless handsets too. That's cause for concern for investors in TI, the world's leading supplier of chips for mobile phones.

HOLIDAY BLUES? Danely expects TI to raise its revenue expectation for the current quarter to the high end of its current projection, which calls for sales of $3.3 billion to $3.56 billion. "The strength has been broad-based, with stronger than expected order rates" for wireless handsets, he notes. Still, he rates the stock neutral, arguing that two key gauges of industry health -- factory utilization and gross margins -- are nearing a peak.

And the typically robust holiday shopping season may not bring the industry much joy this year, as a combination of rising interest rates and surging oil prices conspire to crimp consumer demand, says S&P Equities Analyst Amrit Tewary. TI's sales may rise only 5% in 2005, compared with 28% in 2004, reflecting "moderation in worldwide semiconductor industry growth in 2005," he says. The dour outlook is reflected in a Gartner forecast for PC prices to decline 13% this year from 2004.

If the chip industry's typical historical pattern holds, then a slowdown should be good news for companies such as Applied Materials (AMAT), which supply the chipmakers with the expensive and specialized gear they need to turn out ever-more-advanced chips. In general, when chipmakers feast, capital-equipment companies go hungry, as orders for new manufacturing lines slow. Now, the reverse may be true.

STILL CAUTIOUS. On Aug. 16, Applied Materials reported sales of $1.63 billion for its fiscal third quarter, which was down by 12% quarter-over-quarter and 27% from the year-ago quarter. Profits were down to $370 million, a dip of 21% over the previous quarter and 16% from a year ago.

During a Sept. 7 appearance on CNBC, Applied Materials CEO Michael Splinter said orders were rising, but customers remained cautious about making new purchases. "They're really filling out their lines to add capacity in smaller increments before they make some larger bets maybe later in the year," he said. He won't be the only one waiting to see where the chips fall.

Hesseldahl is a reporter for BusinessWeek Online in New York

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