Stale Chips, Sliding Revenues

The industry is facing what may be its worst slump in a decade, given an end-of-year inventory glut and the impact of Vista

It's been clear for some time that 2007 would be a tough year for chipmakers. What's been less clear is exactly how tough it would be.

Until now. The seasonal slump that hits the industry every January is well under way, and this year's slowdown may be the worst in a decade, with only the faintest hope in the cards for the second half, say analysts and industry groups.

In a research note issued Apr. 3, Merrill Lynch (MER) analyst Joseph Osha gave a dour assessment of the prospects for Intel (INTC) and Advanced Micro Devices (AMD) during the first half of the year. Sales of microprocessor chips that go into desktop and notebook PCs, server computers, and high-end workstations are selling at about their usual volume, but revenues are down as sale prices slide, according to Osha.

Cyclical Woes

The culprit, as with most years, is an inventory hangover from the fourth quarter. With PC makers like Dell (DELL), Hewlett-Packard (HPQ), Gateway (GTW), and Apple (AAPL) having stocked up on chips to meet high demand during the holiday season, as usual, they're ordering fewer chips at the beginning of the year.

This is causing demand to drop and prices right along with it (see, 12/14/06, "Why the Chipmakers Are Down for '07"). "Selling prices appear to be the culprit as OEMs [PC makers] and distributors work to liquidate inventory taken on during Q4," Osha wrote.

But what makes 2007 special? At least one reason is the transition to the Windows Vista operating system. Microsoft (MSFT) has said it sold 20 million Vista licenses in its first month of general release. Still, PC upgrades on both the consumer and enterprise side of the business have been slow to materialize amid questions over whether to upgrade immediately. Meanwhile on the Apple side, new machines and a new operating system are expected early in the summer, kicking off an upgrade cycle that should last well into the second half of the year.

PC shipments grew about 10% in 2006, according to estimates by research firm Gartner, to slightly less than 240 million units, and revenue remained flat, at about $201 billion. The firm has forecast meager unit growth—about 9.9%—and essentially flat revenue growth for 2007.

Price Declines

Demand for servers, the computers that run Web sites and corporate networks, is also being crimped. Virtualization, the technology that lets many operating systems run on a single computer, has been eating into server sales, says IDC, which cut 4.5 million servers from its sales forecast for the second half of the decade. For the period, the researcher now expects unit growth of 39%, from 61%.

Osha's note came on the heels of word from the Semiconductor Industry Assn. that worldwide chip sales in February increased only 4.2% vs. February, 2006, and were down 6.5% from January, or by more than $1 billion. The total revenue reported for the month was $20.09 billion. SIA President George Scalise noted in a statement that sales of microprocessors were up 8%, but that prices on those chips were down by 15%.

Dean McCarron, head of Mercury Research, a researcher that tracks shifts in the microprocessor market, says that while he's seeing price declines, there's no reason for alarm. "It's worse than the usual seasonal pattern, but not vastly so," he says.

Missed Targets

The pain is being felt differently from one chipmaker to the next: Many analysts agree Intel will weather the slump better than AMD. Osha wrote that AMD's inventory troubles are worse than those faced by Intel. He expects Intel to see its processor revenue decline by only 8%, vs. a 20% slide for AMD. "It's apparent that Intel is likely to emerge from the quarter in better shape than AMD, and we expect Intel's Q2 outlook to be better than AMD's as well," he wrote.

AMD said on Mar. 5 that it will likely miss first-quarter revenue targets that had been between $1.6 billion and $1.7 billion. AMD's stock price has been sliding since then. It closed at $12.90 on Apr. 3, down more than a dollar over the last month, and within 10¢ of its 52-week low.

AMD vs. Intel

AMD is said to be readying a competitive response designed to challenge Intel (see, 1/12/07, "Intel Fights Back As Chips Are Down"). The company is near an announcement on a new set of Opteron processors for servers that it's describing as retaking the performance lead from Intel. Additionally, AMD plans to launch a new advertising campaign to hit the point home.

Server chips are traditionally where AMD has given Intel the biggest worry, and it was the first few generations of Opteron chips that did the most damage to Intel's market share over the last few years. But Intel responded and, by most measures, has been ahead of AMD for the last several months.

As of the end of 2006, AMD had been holding its own against Intel in the market share race, according to Mercury Research figures. Its share of the combined market for PCs, notebooks, and servers at the close of the fourth quarter of 2006 stood at 25.3%, up from 23.3% in the third quarter and 21.4% in the fourth quarter of 2005. Intel's share, meanwhile, has been slipping from 76% in the third quarter to 74.4% at the end of the fourth.

And while that's good news for AMD on one hand, Intel's favorite weapon of choice historically when faced with a resurgent AMD has been tough pricing. Combined with a market where demand is worse than it would otherwise be, you have the makings of a difficult first half of the year.

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