Why the PC Slump Hasn't Slowed Pericom
By Sam Jaffe
Oh, what most tech investors would give not to have put their money in computer-related stocks in 2000. The entire industry, from desktop box-makers like Apple (AAPL ) and Compaq (CPQ ) to software companies like Microsoft (MSFT ) and chipmakers like Intel (INTC ), is nursing its wounds and recasting its image after a severe slowdown in growth massacred computer shares.
But amidst the groans and cries for help on the barren PC battlefield, a few companies survived intact and are growing just as much as they were before the current bear market. One such company is Pericom Semiconductors (PSEM ).
Although Pericom's stock is down 57%, to around $20 a share, from its high in October, there's not much reason for the decline other than being caught in the high-tech downdraft. The company is selling its chips at a rapid rate and has had few order cancellations. "When there was a panic, all stocks got caught, whether the growth story was accurate or not," says Manoj Nadkarni, a semiconductor analyst and editor of chipinvestor.com who holds a position in Pericom. "In Pericom's case, the growth is still coming, and the market got it wrong."
The sorcerer behind Pericom's magic touch is CEO Alex Hui. For the past two years, he has engineered a strategy of diversifying the company's manufacturers, its buyers, and its products. As a result, Pericom has been hardly touched by the PC slowdown.
The first decision Hui made early on that has paid off handsomely was a technical one. Pericom makes what are known as interface chips. Those are the specialized semiconductors that allow a computer's memory chip and microprocessor to communicate. Two years ago, the hottest new technology was Rambus's RDRAM (for Rambus DRAM), a new memory chip designed to speed up computers. PC makers like Dell (DELL ) and Compaq spent hundreds of millions of dollars developing new computers that would take advantage of the Rambus design.
But Hui figured out that Rambus' chips were too expensive and were needlessly powerful for most computer users' tasks. Pericom concentrated on making interface chips for other types of next-generation memory. His decision was right on target. Rambus chips have failed to become widely accepted by computer users because of their cost.
Instead, cheaper alternatives like the PC 133 memory-chip design, a standard shared by many chipmakers, now rule the computing universe. As a result of Pericom's early backing of PC 133, it grabbed a big chunk of market share in the notebook-computer niche. "Just about any laptop you pick up will have a Pericom part in it," says Patrick Brennan, vice-president for investor relations at the company.
If the Pericom story finished there, it might still end in tears in this tough market. But another Hui calculation turned out to be even more auspicious for the company. Hui decided to push the company into diversifying its customer base. Since every device with a microprocessor needs an interface chip, Pericom decided to spread out beyond the PC market.
Its greatest success was in making interface chips for the data and telecommunications infrastructure hardware market. That means high-end routers, switches, and hubs made by companies like Cisco Systems (CSCO ), Nortel Networks (NT ), and Sycamore Systems (SCMR ). Thanks to the exploding demand for Internet and data bandwidth, such devices are still hot despite the economic slowdown.
Today, 40% of Pericom's sales are to the data and telecom markets, compared to almost nothing just two years ago. "Our greatest asset is the diversity of products we offer," says Brennan. "We have over 500 separate products, 200 of which have been created in just the last two years."
At the same time, within the computer sector, Pericom concentrated on the higher-end markets of server computers and laptops, both of which are enjoying much quicker growth than desktops. About 15% of its revenue comes from the server market and 22% from notebooks. Only 3% of Pericom's chips go into desktop computers today. "The notebook market has probably been the weakest [of the markets in which Pericom participates]," says N. Quinn Bolton, an analyst with CIBC World Markets, who rates the stock a strong buy. But he adds: "The notebook market will rebound the next three to six months, as the excess inventory is currently being worked off."
Thanks to that diversification strategy, Pericom was able to maintain its revenue and earnings guidance for its second quarter of fiscal 2001, ending Dec. 31. The final results will be announced later in January, but analysts expect the company to sell $36 million worth of chips for the quarter and earn 23 cents a share, according to First Call. The company earned 12 cents per share in the same quarter a year earlier.
Pericom's long-term targets also are holding intact. It expects to increase revenue at least 30% a year for the next few years. Thanks to the nature of the chip business, which benefits greatly from economies of scale, the company's earnings should increase 40% to 60% at the same time, according to chipinvestor.com's Nadkarni.
Pericom also produces the type of earnings stability that Wall Street craves. For the past three years, it has hiked revenue by 40% and earnings by 72% annually, and produced 31 straight quarters of profitability. Since the company went public only in October, 1997, many of those quarters occurred while Pericom was still private.
Clearly, some hurdles remain in Pericom's path. A long-term economic slowdown that causes telecommunications companies to stop buying new equipment would hurt its growth plans. "Visibility remains low into the March quarter, and order cancellations may accelerate again if end-market demand deteriorates further," says CIBC's Bolton.
But the company does have a nice safety cushion in case a prolonged recession starts to hurt the top line. It has stockpiled cash, thanks to a successful secondary share offering earlier this year. As of the close of fiscal 2001's first quarter, which ended Sept. 30, the company declared cash and short-term investments worth $149 million. That's equal to almost $3.50 per share.
Even without factoring in the cash position, Pericom's price-to-2001 earnings ratio is just under 20. That's half the company's most conservative guidance for future earnings growth, a sure sign of a cheaply valued stock. And when investor pessimism reverses course, that's just the kind of stock that could go up furthest and fastest.
Jaffe writes about the markets for Business Week Online in our daily Street Wise column
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Edited by Beth Belton