Comm Chip Doldrums Ahead

In the semiconductor business, droughts usually end in a flood. Now some are predicting that chipmakers, in response to an ongoing components shortage in the networking equipment space, might end up with more manufacturing capacity than they need in the first few months of next year.

An upcoming report from IC Insights on the integrated circuit industry says that a slowing economy, too much manufacturing capacity, and customer inventory corrections will mark the start of a cyclical slowdown in the IC business in 2001. “The problem for IC suppliers is they had too much capacity in 2000, which is good news for their customers,” says Bill McClean, president of IC Insights. “If the systems business is healthy next year, there probably won’t be any problems securing components at favorable prices.”

In late 1999 and early 2000, when networking gear was selling fast, both equipment vendors and chipmakers were wrangling with component shortages (see Cisco: Boom or Bust? ). Chipmakers invested heavily in more manufacturing capacity. Networking gear vendors carried more inventory than normal so as to not disappoint their customers (see Components Shortage Gets Real and Chip Inventory Fears Ease).

Now, thanks to a general slowdown in the industry, networking gear isn’t selling as fast, equipment vendors still have some inventory, and some chipmakers appear to be stuck with all the manufacturing capacity they added in 2000.

McClean’s report predicts that the market for cell-based ASICs (application-specific integrated circuits) will increase 12 percent in 2001. That’s nothing to sneeze at, but nowhere near the 22 percent growth that same sector experienced in fiscal 2000, McClean says.

For the most part, McClean’s thesis has played out in the latter half of 2000. Not long after Cisco Systems Inc. (Nasdaq: CSCO) reported a buildup in inventory levels, analysts, noting a slowdown in demand for communications chips, began downgrading stocks. The most potent of the punches came from Merrill Lynch & Co. Inc.'s (NYSE: MER) Joe Osha, who, in mid-November, cut his ratings on Applied Micro Circuits Corp. (AMCC) (Nasdaq: AMCC), Broadcom Corp. (Nasdaq: BRCM), PMC-Sierra Inc. (Nasdaq: PMCS), TranSwitch Corp. (Nasdaq: TXCC), and Vitesse Semiconductor Corp. (Nasdaq: VTSS).

The firms hurt most by the fallout were those providing chips to the likes of Lucent Technologies Inc. (NYSE: LU), Cisco, Nortel Networks Corp. (NYSE/Toronto: NT), and other large equipment vendors. And, like most stocks related to technology, those chipmakers have watched their market capitalizations disappear by millions of dollars at a time.

Still, a little slowdown in chip demand isn’t necessarily a bad thing long-term, say some analysts; and although McClean’s predictions apply to the IC business as a whole, UBS Warburg analyst David Wong notes that some sectors, particularly chip makers selling ASICs for wireline applications, are still full of healthy companies, even if they’re not momentum stocks.

“I see no reason to think that these businesses will weaken,” Wong says. “Especially those companies selling chips for newer telecom applications, where pricing isn’t much of an issue and performance and reliability matter more.” Wong says his favorites in the bunch are Broadcom, Vitesse, and AMCC.

-- Phil Harvey, senior editor, Light Reading http://www.lightreading.com

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