How to Ride This Chip-Stock Cycle

While semiconductors are down now, Manoj Nadkarni of takes a long view and points to some lesser-known favorites

With semiconductor stocks at a 52-week low, the way up for chip companies is to do a better job of demonstrating new uses for their products. That's the advice of Manoj Nadkarni, founder and editor of

For example, he thinks it would behoove Texas Instruments to push the benefits of cell phones, a big end-market for its chips, and for producers of DRAM chips to persuade PC customers they need more memory for all the latest applications. Despite the current slowdown, he points out that the chip industry's dramatic growth has not been in a straight line. But with all the ups and downs, Applied Materials, for instance, can point to compound annual revemue growth of 25%.

Currently, Nadkarni sees investment potential in IKOS Systems, which makes emulators for very fine chip designs. He's also positive about test-equipment maker Keithley Instruments and automation-equipment companies Asyst Technologies, Brooks Automation, and PRI Automation.

Nadkarni presented this analysis in a chat presented Mar. 1 by BusinessWeek Online on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff and Amey Stone. Edited excerpts from the chat follow. A complete transcript of this chat is available from BW Online on AOL, keyword: BW Talk.

Nadkarni presented this disclaimer: "Different company examples in this chat are for the purpose of illustrating ideas. They are not an endorsement by Mr. Nadkarni or by, nor a recommendation or offer to buy or sell securities. Any action taken by you as a result of the discussion here is strictly at your own risk. Mr. Nadkarni or shall not be liable for any gains or losses resulting from such actions. You should be aware that Mr. Nadkarni has positions in some of the stocks discussed."

Q: Manoj, how does the stock market look to you from a broad perspective? Just volatile or bear territory?

A: Well, certainly with the Nasdaq hitting a two-year low, we're in bear territory, and yes, there's a lot of volatility, too. I might add that the SOX [the semiconductor index] also hit a 52-week low.

Q: How far will the SOX drop from its low today?


Well, I wish I had a crystal ball. We think, though, that a lot of bad news is already built into the stocks. Having said that, it's really difficult to pinpoint when either the SOX or individual chip companies will bottom out.

Q: Why has the chip sector taken it on the chin lately? It seems to be one of the worst-performing sectors of late.


Clearly, there's a slowdown in the chip sector as well as with various technology segments. And what we're seeing is a classic down cycle for semiconductor companies. It's true that the chip industry has grown over tenfold during the past 20 years, but that growth hasn't been smooth and linear.

Q: What do you think about Intel?

A: Intel is mainly a microprocessor company, with 80% of its revenues and most of its earnings coming from microprocessors.... The most important thing for Intel has been the flawless launch of Pentium 4, the latest desktop microprocessor. With that, the company has regained a performance lead.... Intel has a strong leadership position in mobile processors, with healthy margins, and in addition, the company will likely improve its presence in the server-processor markets.

Obviously, the most negative factor is the current economic slowdown.... Also, the company may see some pricing pressure on midrange processors from AMD. And flash memory may also see some pricing pressure. So in summary, there are many positives and some negatives, but the valuation today is much better than a year ago.

Q: Your views on IDTI [Integrated Device Technologies]?

A: IDTI has done very well in the past few years, especially with the new CEO. The company has a broad portfolio of communications chips. One concern we have with midsize companies like IDTI is that with their own manufacturing plants, when there's a slowdown, the fixed costs are higher compared to a company that doesn't have fabrication.

Q: What's your opinion on AMAT [Applied Materials]?

A: The company is expecting a sequential drop in revenues that's in line with the drop we're seeing for the equipment industry as a whole. But we think Applied (AMAT ) will maintain market share in deposition, etch, and CMP [chemical mechanical polishing] tools, and perhaps improve upon it. The company has promising 300-mm products, too. Applied Materials exemplifies the typical, cyclical, nonlinear growth that the chip-equipment industry has demonstrated.... The company has had a compound annual revenue growth rate of over 25%, even including down cycles.

Q: What about Texas Instruments (TXN ) at these levels?

A: This is a good company focused on digital signal processing technology and analog chips. However, like other large and small chipmakers, the company is experiencing a pronounced slowdown. Chip companies like TI will likely come out of this downturn by the end of this year.... One of the things that companies like TI need to do is to create new demand for their chips. And they can do that by explaining benefits of their chips and technology to new users.

Q: Can you tell us what's going on these days with DRAM [dynamic random-access memory] supply and pricing?

A: As you know, DRAM is the primary memory type used in PCs. DRAM prices have come down significantly in the last six months. It's a good indicator of excess capacity.... DRAM producers have not yet made a strong case to consumers and businesses about the benefits of putting still more memory in PCs. We think there's tremendous opportunity for better performance with the latest Internet content creations, photo editing, text translation, and a variety of other applications.

Q: Manoj, in discussing DRAM, you touched on promising new technologies and markets. What are some others, and the companies connected with them?


One is the use of copper interconnects [connections between millions of transistors on a silicon chip] and low-K dielectrics [high-performance insulation for the metal interconnects]. Another trend is migration to 0.13-micron technology. And even during a slowdown, there's a lot of new chip-development activity. So companies that enable chipmakers to move to new designs are benefiting.

One such company we like is IKOS Systems (IKOS ). It makes emulators for very fine chip designs. This technology was originally developed at MIT.... IKOS expects revenues to be up about 20% or 25% this year, and earnings should grow more than that. As a disclosure, we have a buy rating, and I have a position in IKOS.

Q: I think TQNT [TriQuint Semiconductor] is a great buy -- what's your opinion?

A: TriQuint has been our favorite in the past. It makes chips using gallium arsenide substrate. It has the broadest technology and product portfolio in gallium arsenide. The barriers to entry are higher, and the company has a large exposure to the cell-phone business.

Q: Will AMD continue to gain market share and be more profitable than Intel over the next 24 months?

A: That's a fine question. AMD's Athlon processor has been one of the biggest success stories in chip-industry history. And with that, the company's market share rose from 14% to 17%. It's ahead in implementing copper interconnects, and with no comparable Intel chips yet at 1.1 and 1.2 gigahertz, AMD should do well in the midrange of desktop processors. On the other hand, with the introduction of Pentium 4, Athlon is no longer the most powerful desktop processor.

Q: I know everyone is wondering what chip stocks you'd recommend for buying now. You mentioned IKOS.

A: Another of our favorites has been Keithley Instruments (KEI ). The company makes test equipment for semiconductor telecommunications and opto-electronics industries. It's very well managed. It's rare to find a company with operating margins above 20%, with a revenue run rate of less than $50 million a quarter. That's a solid financial-performance measure.

Also, we like automation-equipment companies because of the upcoming 300-mm manufacturing facilities, where fabrication automation will play a critical role. In this space, the leading companies are Asyst Technologies (ASYT ), Brooks Automation (BRKS ), and PRI Automation (PRIA ). And I want to add that we do have a position in Keithley Instruments and Asyst Technologies.

Edited by Jack Dierdorff

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