*Extra* Daily Interview: The Intel Fallout

How bad is it?

That's one of the many questions on everyone's lips after Intel(INTC) rocked Wall Street late yesterday with another warning about first-quarter results. First-quarter revenue will be down not just 15% but 25%, the company said. Further, it will trim 5,000 jobs through attrition to cut costs. Any trouble at the chipmaker, whose name has become nearly synonymous with bellwether, sparks widespread concern about the broader impact on the tech sector. Last time Intel warned, it presaged an onslaught of "confession season" notes from tech companies. Intel is off 12% out of the gate this morning, and it's dragging down the Nasdaq Composite Index and the Dow Jones Industrial Average with it.

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In an extra Daily Interview for today, TheStreet.com spoke with Standard & Poor's director of technology research, Megan Graham-Hackett, about the reverberations to be felt from Intel's warning.

TSC: Intel had warned that first-quarter earnings would be down 15% from the previous quarter, and yesterday, they announced it will be 25%. Why didn't the company and analysts anticipate how steep the drop-off would be?

Graham-Hackett: The weakness appears not to be coming from the microprocessor for PCs, but from communications chips as well as flash memories. Those areas have not been as big a driver in earnings or revenue in the past. That's very surprising given the fact that these have not been large profit areas for Intel. Apparently, they misforecast some of the new markets they have penetrated in communications chips and networking.

TSC: Why have communications chips, for telephones and wireless devices, and flash memory become important to Intel now?

Graham-Hackett: They've potentially grown these businesses to become much larger than anyone had anticipated. Most analysts have said that flash memory also is poised to weaken given that pricing in that area has come under pressure. But obviously from Intel's comments last night, they saw a dramatic change in the flash memory business.

What I also heard last night was they are facing a confluence of events. They have no place to hide in any of their product lines. In addition, they have no place to hide geographically. They are seeing weakness across the board.

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Now, their comments on the server side are a little more difficult to understand. They said that their ASP market share is holding up market but that the server business caused additional pressure for this quarter that they didn't anticipate. I cover computer hardware companies. Compaq(CPQ) and IBM(IBM) as of last week were saying that their low-end server business, which is the Intel processor-based server business, was growing very well in an environment where PC spending has been quite tight. They said that instead of buying mid-range systems, companies are buying smaller boxes in the interim until they can find out where their business is going because they need the additional capacity.

That contradicted what I am hearing from the computer makers, so that is a little bit disturbing. It's possible that the hardware makers are seeing this weakness in the microprocessor market but are not admitting it.

TSC: When Intel warned of earnings disappointment in the fourth quarter, it precipitated a slew of other earnings warnings. Does this portend another rash of earnings disappointments and downgrades for the first quarter?

Graham-Hackett: I believe that the kind of dramatic deceleration does in fact indicate that we could see additional negative earnings warnings. The areas I see susceptible are companies exposed to flash memories because obviously that's gone down quite dramatically. In the communications chips market, we've seen many of those preannouncements already. Intel, because it is a newcomer to that market, must have expected greater penetration. To change their earnings warning from 15% to 25%, they have obviously been caught off guard because, as we know, that whole market has been under pressure for quite a while. It hasn't been just for the past couple of weeks.

TSC: Besides flash memory, communications chips and even low-end servers, are there other related industries that could also be dragged into this downdraft? Micron(MU), Xilinx(XLNX) and other chipmakers, for instance, have rallied over the past couple of days. Could this put a kibosh on the chips?

Graham-Hackett: It's tough to say. A lot of the chipmakers have already warned and the news has been built into their price. Xilinx already put out the bad news. They are exposed to the communication chip that Intel talks about. With Micron, the exposure there is to DRAM and that they've already worked through DRAM inventory.

But Intel is a bellwether for technology, and an announcement of this kind does have magnitude throughout the industry. It's a shaky market, and this will probably put pressure on a number of groups. The next-closest company to Intel that will probably suffer is Advanced Micro Devices(AMD) because they are also a big participant in flash memory. If Intel says they haven't lost market share to AMD, then AMD is probably susceptible.

TSC: What does Intel's news mean for the widespread theory that the economy will improve in the second-half of the year?

Graham-Hackett: Intel is admitting that things are bleak but they maintain that things should start to improve sequentially in the second half. That's still a tough bet. I would warn that we still have inventories to work through. We may even be seeing the first signs of the U.S. economy's weakness beginning to spread internationally. Then, the second-half rally theory is going to be debunked.

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