Forget a Second-Half Rebound for Communication Chip Makers

It's time to put to rest any remaining hopes that the communication-chip sector could still be part of the second-half turnaround that some semiconductor companies are predicting.

During Applied Micro Circuit's (AMCC) dismal conference call Tuesday, Chief Executive Dave Rickey said what other communication chip makers hadn't yet said quite so plainly -- evidence of a second-half turnaround is "theoretical" and "anecdotal" at best. In other words, the company hasn't seen any real signs of a rebound; it only has heard from customers that it could happen, which is hardly reassuring.

That fact has analysts lowering estimates for Applied Micro. Other companies, including Broadcom (BRCM) and PMC-Sierra (PMCS), are facing similar problems, too. Yet even as communication chip makers' earnings estimates for 2001 and 2002 are falling, their stock prices are hanging tough, which is creating some lofty valuations.

Applied Micro's comments Tuesday come after other chipmakers, with both a little and a lot of customers in the communications sector, have said during the past 10 days that they don't expect that business to start to improve until late in the year. Intel (INTC), for instance, said last week that it expects its personal computer-related business to bottom out in the second quarter but expects communications to have a slower recovery starting "sometime later this year."

The problem is that the customers, big communication and networking companies like Cisco (CSCO) and Nortel (NT), are struggling with their own tepid demand and overflowing inventories. It's unclear when that might change. Even Cisco's $2.5 billion inventory writedown won't necessarily help ease the pain -- the company now can use that written-down inventory when it needs to instead of buying more.

So for the foreseeable future, companies that feed the telecommunications and networking industries with chips are going to have a rough go of it.

Wall Street has begun to rediscover that this week. Merrill Lynch on Monday took its targets and ratings down for a host of companies, including Applied Micro. And now with Applied Micro's numbers and fiscal first-quarter forecast in hand, analysts are making their first stab at earnings for the fiscal year ended March 2003. It's not pretty.

Merrill, for instance, sees Applied Micro earning all of 7 cents in fiscal 2002 ended March and then 20 cents in fiscal 2003. Both of those are down from the 48 cents the company earned in fiscal 2001. And based on a recent stock price of $23, the stock is trading at 304 times 2002 earnings and 87 times 2003 earnings. "At these levels, we think it makes sense to reiterate our intermediate term Neutral rating on the stock," analyst Mark Lipacis wrote in a research note. (Merrill hasn't done underwriting for Applied Micro.)

Like one-time high-flyer Applied Micro, Broadcom and PMC-Sierra also appear expensive.

According to Thomson Financial/First Call, Broadcom is expected to break even this year and earn 42 cents in 2002, down from $1.04 in 2000. At a recent stock price of $35.31, that means that it's trading at 84 times 2002 earnings. PMC-Sierra, meanwhile, is expected to earn 11 cents this year and 57 cents in the following year, down from the $1.05 it earned this year. At $37.38, its price-to-earnings ratio for this year is 340 and is 66 for 2002.

Investors seem to have priced in a lot more than hope.

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