Taiwan Semiconductor Feels Chip Sector's Pain

Cisco(CSCO Quote) wasn't the only tech giant with bad news staring it in the face.

Yesterday's earnings report from Taiwan Semiconductor Manufacturing (TSM Quote) contained a downbeat assessment of the chip industry's immediate prospects. Sound familiar?

Taiwan Semiconductor is the world's largest chip foundry, essentially a contract manufacturer that makes semiconductors for about 300 companies, including Intel (INTC Quote), Altera (ALTR Quote) and Motorola (MOT Quote). More than two-thirds of its customers are North American-based companies. "We consider them the best barometer of the health of the semiconductor industry," said Steven Pelayo, an analyst at Morgan Stanley.

And what is the reading? Nothing good, at least not for a while. "I don't want to call 2001 a throwaway year, but it's pretty bad," said Pelayo, who covers semiconductor equipment makers for the brokerage.

In its earnings call yesterday, Taiwan Semiconductor's CEO, Morris Chang, said the company expects a breathtaking drop in business: from last year's rate of having more than 100% of its wafer-making capacity in use to an expected rate of 70% for the coming two quarters. Chang forecast that the slump will last through the second quarter, although he acknowledged that the ability to forecast even that far was limited. TheStreet.com's George Mannes recently wrote a story looking at how tech companies are having a harder time making forward-looking projections.

Chang's model has orders in the semiconductor industry picking up in June and finishing the year strongly. But not everyone is so sure. J.P. Morgan analyst Lucas Ward wrote a note this morning that Taiwan Semiconductor's customers might be predicting an uptick in business on an "unrealistically rapid recovery" of the U.S. economy. Taiwan Semiconductor was lately off 2% to $20.16. It's 52-week low is $16.12.

Chang also announced that his company would slash its capital spending for equipment by 29% to $2.7 billion. This is not good news for equipment makers such as Applied Materials (AMAT Quote), KLA-Tencor (KLAC Quote) and others who have already been hit because corporations' capital expenditures have hit the skids.

ING Barings analyst Nikolay Tishchenko predicted that with other foundries following TSM's lead, Applied Materials could see bookings for the current quarter fall by 25%. In recent trading, it was down 4.4%. KLA-Tencor was trading 3.6% lower.

One bright spot for the equipment makers: Taiwan Semiconductor, along with other chip-makers, will continue a trend in the sector toward making larger wafers and smaller circuits. These new standards mean the companies will have to order new manufacturing equipment. Still, Pelayo said, he estimates spending for semiconductor equipment will be down 15% to 20% for the year.