Egos, Big Bank Accounts Keep Comm-Chip Makers Single

The richest of the bunch, Applied Micro, claims $1 billion in cash and short-term investments and no debt. Though the company hasn't posted an after-tax profit since the September 2000 quarter, it's been steadily reducing its losses and now burns cash at the rate of less than $10 million a quarter.

A Long Way From the Poorhouse Comm IC war chests
Company	Cash and Short-Term Investments
Applied Micro Circuits	$1.04 billion
Broadcom	573.7 million
Conexant	397 million
Exar	310.5 million
PMC-Sierra	421.9 million
Vitesse	312.2 million
Source: Company filings from 10-K Wizard

Another practical obstacle to consolidation: Because comm IC outfits have no idea when demand will resume (or even what "normal" demand would look like, following the wild late '90s buildout), bankers would have a tough time assigning value to a potential acquisition candidate.

Many analysts agree that corporate egos are just as important a hurdle. CEOs at communications-chip outfits "tend to believe they are the best-positioned company, that they're likely to be a consolidator rather than be consolidated," says Liang.

Then there's the relatively uninspiring record of chip company mergers. "Historically, consolidation in semis hasn't worked like it has in other industries," says Alex Gauna, an analyst at UBS Warburg. Chip M&A carries special risks due to the built-in obsolescence of semiconductor technology, he explains. "You can get a rich cash balance [from an acquisition], true. But if you don't keep the engineers and design momentum, you've acquired a product that goes out of date 12 to 18 months into the future."

As examples of recent acquisitions that failed to live up to expectations, he points to Intel's $2.2 billion acquisition of Level One Networks and Applied Micro's $4.5 billion purchase of MMC Networks.

For all these reasons, don't expect much M&A among comm IC suppliers any time soon. But don't expect a snapback to health either, because in the absence of consolidation, the industry seems destined to struggle with excess supply and stiff price competition.

That outlook was summed up by U.S. Bancorp's Kumar, who issued a note titled "No Turn in Sight" on the sector this week. "Comm IC stocks remain trades, not investments, as the companies will fail to earn a return on capital that exceeds cost of capital," predicted Kumar.

Having already lost investors' confidence, the industry faces a wrenching path to recovery. "If there's no consolidation and no demand uptick, I think there will be additional rounds of layoffs," predicts Liang. "The way to preserve cash is to reduce expenditures. And the most straightforward way to do that is through continued layoffs."

Even so, the comm IC industry may only be postponing the inevitable. "I think at some point we will see consolidation, but people are trying to hold out," says Whyman. "It's like a game of musical chairs. Everyone wants to believe they'll be in the chair when the music stops."