The Chips Are Piling Up at Semiconductor Makers

And the dot-com crash is only one cause of bloated inventories

On eBay, the bidding on a 1998 Holiday Barbie is closing at $40. A few clicks away, a 1940s-era clamshell-shaped soup tureen is going for $12.95. And a Cisco Systems Inc. 2501 ethernet router, just months old, languidly gets bid up to $99.

The 2501 is not exactly a hot collectible. In fact, eBay and other auction spots are lousy with bargain-basement routers, servers, and other high-tech industrial gear. That's bad news for Cisco (CSCO ), Lucent Technologies (LU ), Sun Microsystems (SUNW ). And it's just as bad for the companies that sell them semiconductors. On the heels of a record $204 billion in sales last year, the chip industry is girding for a 20% contraction. The cause: a double whammy of oversupply and a slowing economy.

DRY SPELL. Chip companies are accustomed to roller-coaster cycles. Once, in the mid-1980s, the industry suffered a harrowing 17% plunge. But the current chip slump is shaping up to be "the worst I've ever seen," says T.J. Rodgers, CEO and founder of Cypress Semiconductor Corp. (CY ) in San Jose, Calif., and a 26-year industry veteran.

Recent industry data bear him out. Orders began drying up late last year, and sales this year have fallen off a cliff. Cypress' first-quarter revenues sank by 29%, compared with last year's fourth quarter. Turnover at LSI Logic Corp. (LSI ) shrank by 31% in the same period. Signal processor giant Texas Instruments Inc. (TXN ) is off 17%. The sector as a whole is down 18% in the first quarter. And Intel (INTC ), the world's largest chipmaker, doesn't see a turnaround this year.

It's the dot-com crash that knocked chips over the edge, says Jim D. Feldhan, president of Semico Research Corp. in Phoenix. Cash-rich dot-coms loaded up on gear last year. But customers didn't materialize, and venture capital evaporated. Now the surplus is being liquidated on sites such as eBay (EBAY ), and at Inc.'s "Death of a Dot-Com" sales events.

Slack consumer demand is the other big headache for chipmakers. Worldwide sales of personal computers---the biggest source of demand for chips--will grow by just 5.8% worldwide this year, according to market researchers IDC. In the U.S., unit sales will shrink by an unprecedented 6.3%, IDC analyst Roger L. Kay predicts, adding that "consumer spending is really in the tank." Says Mark L. Edelstone, an analyst at Morgan Stanley Dean Witter & Co.: "If gross domestic product growth falls below 1.5%, [semiconductors] could contract by more than 20% this year."

Communications markets, the second-biggest sponge for silicon, are hurting, too. For every unit of inventory held by a PC company, there's three times more in the warehouses of the communications makers, according to Edelstone. Under the best scenario, he doesn't expect cell phones and other consumer devices in this category to begin growing again until early 2002.

If--and it's a big if--demand picks up and the equipment makers can work off their surpluses, the chip market could bottom out late this year, says Steve L. Cullen, an analyst with Cahners In-Stat Group. But even then, revenues won't hit 2000 highs again until 2003.

ON FAITH. Then it's back to steady growth, right? Well, yes in terms of production, but maybe not for profits. It will all depend on a new generation of chipmaking technology that's arriving this year and should start going mainstream by 2004. Today, chips are diced from silicon wafers that are no more than 200 millimeters wide. The new approach uses 300-millimeter wafers, and each yields more than twice as many chips. If too many chip companies jump to 300 millimeter too quickly, it's a recipe for more overcapacity.

Still, the industry is pushing forward, compelled by faith in Moore's Law--the dictum that new chips double in power every 18 months, while prices for existing chips halve. Faster, cheaper chips have driven industry growth for the past 30 years. "The glut itself, and falling prices, stimulate demand of unthinkable dimensions," enthuses Rodgers.

That may be going too far. But in the face of their worst-ever recession, semiconductor makers are keeping a brave face. "We know this too shall pass," sighs Brian L. Halla, president, CEO, and chairman of National Semiconductor Corp. (NSM ) Pass yes, but just how painfully remains to be seen.

By Adam Aston in New York

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