Amid Demand and Inventory Woes, Intel Throws a Potential Price War Into the Mix

Move over inventory. There's another threat to chip earnings taking hold for 2001. Pricing pressure.

With semiconductor giant Intel (INTC) due to share its first-quarter results -- and hopefully some insight into the rest of the year -- with the public on Tuesday after the regular trading day ends, Wall Street analysts are questioning their full-year earnings estimates. In part that's because Intel cut prices over the weekend on its new Pentium 4 chip, raising concerns that it won't make the profit margins it needs to meet 2001 earnings-per-share estimates.

Lower prices are nothing new of course -- it's the nature of the business for semiconductors to become both faster and cheaper. But these cuts may be happening more quickly than anticipated and could spark a price war just as Intel and other microprocessor makers like Advanced Micro Devices (AMD) are fighting to overcome weak demand.

The price cuts are coming at a time when Wall Street is as divided about the semiconductor sector as it ever has been. There are some analysts and investors who believe that semiconductor fundamentals have deteriorated so much they can't possibly get much worse -- indicating that the sector's bottom is close. Others in the chip business argue that just because supply and demand are already way out of balance doesn't mean things can't get worse. The push and pull of those two theories is of course taking its toll on semi stocks, which rose sharply at the end of last week, only to cede some of their regained ground on Monday.

Some Clarity

What's clear is that with or without trying to predict the moment at which the sector bottoms, the outlook for lower chip prices and weaker profit margins means that any return to grandeur for chip earnings won't take place this year, and perhaps won't happen until later in 2002.

Lehman Brothers analyst Dan Niles, for instance, says that Wall Street's 2001 consensus estimates for Intel and AMD are based on a certain pricing structure that's no longer accurate. This indicates that the consensus estimate for Intel of 65 cents a share in earnings in 2001 needs to be cut, says Niles, whose own estimate for the year remains at 65 cents. (His firm hasn't done underwriting for AMD or Intel.)

Over at Morgan Stanley, analyst Mark Edelstone has already begun factoring the price cuts into his estimates. Edelstone says that the aggressive price cuts are going to hurt Intel's earnings this year and next, and he lowered his 2001 estimate to 45 cents a share from 60 cents a share. He cut the 2002 estimate to 65 cents a share from 94 cents a share. The consensus for 2002 is 98 cents a share. (Morgan Stanley hasn't done underwriting for Intel.)

Even Edelstone's 2002 estimate is a far cry from the $1.65 a share that Intel earned during 2000 when the semiconductor sector was booming.

Dynamics

The dynamics behind the lower chip prices are multifold. For one thing, demand for personal computers is off. Way off. And that means that PC companies like Compaq (CPQ) and Dell (DELL) are facing their own pressure to lower costs, no matter what kind of chip is inside.

Intel introduced its high-end Pentium 4 chip back in November and has said that it plans to transition to this chip more quickly than it has in the past, pushing its former top models down the food chain. According to Intel, the list price on the 1.5-gigahertz Pentium 4 fell 19% to $519 from $637 effective April 15. The 1.3-gigahertz Pentium 4 also went down 19% to $268 from $332 and the 1.4-gigahertz Pentium 4 declined by 11%. After the company introduces its 1.7-gigahertz Pentium 4, Niles wrote, those prices will fall even further due to an additional price cut on April 29. Intel last cut prices on March 4.

One reason for these cuts is competition with the smaller AMD, which Niles believes has gained market share during the most recent quarter. By moving its prices down so sharply, Intel forces AMD to cut its prices, he says. AMD last cut prices on its high-end Athlon chip on March 5 and is expected to cut prices again soon. AMD is due to announce earnings on Wednesday after the market closes, and according to Thomson Financial/First Call analysts expect earnings of 33 cents a share.

The next two days may bring some clarity to just how much pressure AMD and Intel will be under to make the 2001 estimates.

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