Chip Companies Won't Outgrow Their Customers

"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.