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Optical/IP

Investors Ease Broadcom Battering

For two straight days in the communications chip space, investors used a sledgehammer to destroy the papier-mâché that had become Broadcom stock. In other words, they overreacted, according to many observers.

Investor concerns stemmed from Cisco Systems Inc. (Nasdaq: CSCO) saying this week that it would not be accumulating as much inventory in the next couple of quarters as it has in the past. “This could cause an inventory correction and decelerating revenue growth in the communications chip space,” wrote W.R. Hambrecht & Co. analyst Jim Liang in a note to clients.

Next, W.R. Hambrecht & Co. dropped its rating on Broadcom Corp. (Nasdaq: BRCM) from “Strong Buy” to “Buy” and Broadcom's share price began a freefall, as did other Cisco suppliers in the communications chip universe.

On Wednesday, Broadcom shares dropped $24.69 to $151.81; Applied Micro Circuits Corp. (Nasdaq: AMCC) dropped $7.56 to $61.31; PMC-Sierra Inc. (Nasdaq: PMCS) dropped $19.19 to $108.69; and Xilinx Inc. (Nasdaq: XLNX) slipped $8.38 to $58.31. Broadcom and PMC-Sierra, which both see more than 15 percent of their revenues from Cisco, have each lost more than 30 percent of their share value in the past five days.

Indeed, analysts and investors are right in assuming that if Cisco tightens up on inventory, it will mean less revenue growth for some of its components suppliers in the next quarter or two. Cisco, after all, has only been stuffing the shelves in order to weather component shortages of various kinds without forcing its customers to wait longer for its products (see Cisco's Optical Customers Face Delays).

But does that mean that Broadcom is doomed and Cisco is no longer buying its ICs? Hardly (see Broadcom Posts Record Q3 Revenues). “What Cisco’s really saying is we’re trying to manage our inventories, not we’re not going to be having any demand [for components],” says Seth Spalding, director at Epoch Partners, an investment bank.

“This was a big overreaction on the basis that the fundamental reason for Cisco stockpiling components is because of strong demand for its finished products,” Spalding says. “The components guys are in a great spot.”

For the sake of comparison, an A.G. Edwards report noted the following: In its most recent quarter, Cisco had inventory levels of $1.96 billion supporting sales of $6.5 billion. Lucent Technologies Inc. (NYSE: LU) has inventory levels of $5.4 billion supporting $9.3 billion in sales, and Nortel Networks Corp. (NYSE/Toronto: NT) has inventories of $4.1 billion supporting sales of $7.3 billion."

On Thursday, Broadcom responded to investors' worries by saying it was OK with analysts' estimates for its current quarter. Broadcom says it expects a sequential quarterly revenue percentage growth in the mid-teens and pro forma diluted earnings consistent with analysts' estimates of $0.31 a share.

By midmorning Thursday, investors responded by sending Broadcom shares up about $5 to over $157. PMC-Sierra also rose $4 to over $113, and the rest of the communications chip sector was seeing slight gains.

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

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