Chip Companies Won't Outgrow Their Customers
K.C. Swanson
10/08/02 - 07:01 AM EDT
Despite all the ugly news on the telecom front, investors still haven't factored in realistic expectations for the silicon used in communications. For now, that's created a glaring disconnect. But at some point, a grudging Wall Street will have to rein in its growth outlook for companies that make communications circuits.
In a research note issued Monday, Lehman's Dan Niles points out that analysts expect programmable logic device makers
Xilinx (XLNX Quote) and
Altera (ALTR Quote) to post sales growth of 18% to 21% in calendar year 2003. But that rosy outlook doesn't coincide with the prospects for the companies' biggest clients: communications outfits such as
Cisco(CSCO Quote),
Lucent(LU Quote), and
Nortel(NT Quote).
The networking companies are expected to show flat revenue growth next year.
"Future growth forecasts for the PLD vendors seem out of alignment with some of their biggest customers," Niles said. The disparity is worth noting because networking is the biggest end market for both Xilinx and Altera, accounting for 31% and 25% of revenue, respectively, in the most recent quarter.
Throw in business from (likewise-besieged) wireless and wireline customers, and Xilinx draws a whopping 61% of revenue from communications, while Altera gets 49%.
That's a particularly painful revenue skew, given that business at big communications names is still deteriorating. On Monday,
Intel CEO Craig Barrett said he expected the communication sector's troubles to continue through the end of 2003 or the beginning of 2004, according to reports. In other words, the fortunes of major communications-chip buyers don't look likely to pick up anytime soon.
Both Xilinx and Altera have outlined lousy to mediocre sales expectations for the just-ended quarter, with Xilinx guiding for revenue to fall 3% to 7% sequentially and Altera expecting revenue to be flat to up 2%.
"The good news is valuations have fallen substantially, but we believe there is still downside given the contraction seen at some of their larger customers and potential EPS cuts ahead," Niles concludes. "It is hard for us to imagine PLD growth at 18-20+% while growth of the Big 3 communications customers remains flat."
Accordingly, he's trimmed earnings expectations and dropped his fiscal-year 2004 revenue-growth outlook for Xilinx to 16% from 20% and his calendar year 2003 revenue-growth outlook for Altera to 14% from 18%.
Monday, both stocks closed down, with Xilinx losing 88 cents or 5.6% to $14.85 and Altera off 51 cents or 5.4%, to $8.92.
Unwarranted Optimism
Among communications chipmakers, the story is similar: In some cases, Wall Street clings to forecasts that seem exceedingly optimistic, to put it mildly. Take
Applied Micro(AMCC Quote), which last year drew a combined 25% of sales from Nortel and Cisco. Though its biggest customers are reeling, analysts expect AMCC to post sales growth of a whopping 31% in calendar year 2003, according to Thomson Financial/First Call.
To be sure, the increase would take place from a pretty low base, given that the Street expects revenue for 2002 to be only $123 million. But those still seem like pretty hopeful numbers, given the blight across telecom land.
Another case in point is
PMC-Sierra(PMCS Quote), which pulled in more than 20% of revenue from Cisco and Lucent in 2001. Yet analysts expect the company's revenue to grow 35% in 2003, to $315 million.
Of course, analysts have started selectively chopping estimates on some names. In September, Merrill Lynch cut 2003 earnings and revenue estimates on Applied Micro, PMC-Sierra and
Vitesse(VTSS Quote) based on a slew of negative preannouncements from their customers, the communications equipment companies.
Like Niles, Merrill analyst Mark Lipacis points out that if the equipment outfits are ailing, the chip companies themselves are bound to suffer the same ills. Chip companies' customers now consume silicon at a rate comparable to the second quarter of 1998, he says -- so that means chipmakers are likely to post sales at a similar level.
Lipacis says his revenue estimates for communications chipmakers in the fourth quarter this year are now at or below June 1998 quarter run rates.
Meanwhile, he expects AMCC to grow by only 14%, well below Street expectations for 31%, while PMC-Sierra should increase sales by just under 33%, a little less than consensus estimates of 35%. In both cases, Lipacis believes that growth will take place off a 2002 revenue base that's below Street forecasts.
On a related note, on Monday Prudential cut its rating on the communications chip industry to market underperform, from its previous outperform rating, citing the lagging fortunes of potential customers.
"We believe 2003 will be another challenging year for communications-semi names, particularly for those with overweighted telecom exposure, with consolidation starting to occur, albeit at a slower than initially expected rate," writes Hans Mosesmann.
As a bearish indicator, he points to continued cuts in telecom companies' capital expenditure budgets: the cost-cutting moves have squished hopes for spending growth that could trickle down to chipmakers.
