Chip Gearmakers Shouldn't Fear the Capex Grim Reaper

The party for chip equipment companies died in 2001. After semiconductor makers spent like drunken sailors on equipment the previous year, 2001 brought sobered-up capital markets, skidding economies and massive scaling back in expenditures for chip equipment.

In the past few weeks, the chip companies with the largest capital expenditure budgets have announced even more cutbacks for 2002. The biggest of them all, Intel , held firm in 2001, but as 2002 opened it lopped 22% off its budget for the new year, a harbinger of cuts across the chip sector.

That means billions of dollars in capital expenditures that aren't going to chip equipment companies. While chip investors must decide if they like the industry as much as they did during free-spending 2000, there are reasons to challenge the assumption that investors have a year of hibernation ahead of them.

First off, 2002's numbers aren't a swig of instant death for the equipment companies. The most free-spending chipmakers out there are cutting their budgets from 25% (as in Intel) to as much as 62% (from Infineon ). While Infineon's drop from $2 billion to $800 million is dramatic, remember that chip leaders have been cutting back for several quarters. This means equipment companies already saw depressed spending levels as 2001 progressed.

For example, Texas Instruments (TXN) reported results Monday after the bell and reduced its capital expenditure budget to $800 million from a $1.8 billion outlay in 2001. Equipment makers have been feeling the pain all year, though, because TI spent over $900 million in the first quarter, followed by a sequential Scrooge-like decline to $342 million in the second quarter, $312 million in the third quarter and $236 million in the fourth. Going from $236 million in the fourth quarter, $800 million for the full year is not as startling as it may seem.

"At $800 million, our capex level would be pretty flat on a quarter-to-quarter basis," said Texas Instruments CFO Bill Aylesworth.

Incredible Shrinking Capex Chip companies plan to pony up even less than last year for capital expenditures.
Company	2000	2001	2002 Estimates	Decrease
Intel	$6.67 billion	$7.3 billion	$5.5 billion	-22%
Samsung	$3.1 billion	$3.2 billion	$2.29 billion	-28%
TSMC	$5 billion	$2.2 billion	$1.65 billion	-25%
Texas Instruments	$2.76 billion	$1.8 billion	$800 million	-55%
ST Micro	$3.3 billion	$1.7 billion	$1.2 billion	-29%
Infineon	$1.65 billion	$2.08 billion	$796 million	-62%
Source: Company statements

Another potential shift is that as chipmakers retrench, they will spend less on building new manufacturing locales and more on the equipment that goes into them. Intel noted in its fourth-quarter conference call that while its budget is going down $1.8 billion, it will spend about 50% on equipment, with 33% on construction, making its actual equipment spending drop less than $1 billion.

Money Will Follow New Processes

Texas Instruments goes even further as Aylesworth insists that of TI's more modest budget, "a very high percentage will go toward equipment targeted in advanced areas." He says TI's facilities in Dallas and around the globe will fill its needs in 2002, giving it room to spend its $800 million on 0.13 micron, 300 millimeter wafer and copper interconnect equipment.

Though it's not a huge surprise, investors may want to follow Aylesworth's comments and look into companies with the latest and greatest equipment. Granddady of them all Applied Materials and smaller rival Novellus excel in those areas, as does Brooks Automation, (BRKS), which outfits the more highly mechanical operations of sophisticated technologies.

"The world's swimming in 0.25 micron capacity," said Morgan Stanley's Steven Pelayo, explaining the low utilization rates investors have seen chip companies report. "But 0.18 micron and below is very tight, including 0.13 and 0.15. It's probably running at 80%- to 90%-plus rates. If a chipmaker is still making investments it's at the leading edge, which will be the mainstream of the next cycle." That will benefit chip equipment companies with a technology advantage -- those selling for the 300-micron processes, for example.

Spending budgets also tend to change over time. Take technology giant Samsung, which finished 2001 having doled out on 31% of its original capex plan. Samsung's projections changed several times during the year, falling each quarter to reflect demand. Budgets could go up the same way if the much-anticipated second-half recovery in PCs and mobile phones materializes. As Micron spokesman Sean Mahoney illustrated, Micron spent $1.7 billion on manufacturing in 2001, but as the year progresses, its 2002 estimated expenditures of $1 billion are truly estimates that "could be adjusted as business dictates," he says.

What remains for the investor to consider is whether an equipment stock looks as interesting when capex no longer matches the jaw-dropping levels of 2000 or even 2001. Inevitably the chip cycle will run its course and spending will rise again. But as Deutsche Banc Alex. Brown's Timothy Arcuri argues, "If you're going to look at what happened in 2000, that was arguably a perfect storm on the upside. But that was a very different financing environment than today. Access to capital is much different," he says.

"A lot of companies were spending on equipment that's still sitting in warehouses," according to Arcuri. Investors have to prepare themselves for a future uptick that is strong, but compared to 2000, "relatively speaking might not be that great," he says.

Considering that, the run-up in chip equipment stocks seems too optimistic, even given their traditional role in leading the upward cycle. Applied Materials gained 47% from Oct. 1 to the end of the year, while Novellus rose 51%, KLA-Tencor shares added 70%, ASM Lithography (ASML) climbed 63% and PRI Automation rocketed up 144%. Even the recent earnings news and the capex revisions contained in them haven't rocked the stocks, which are at or above where they ended the year.

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