Egos, Big Bank Accounts Keep Comm-Chip Makers Single

After two years of abysmal business in techland, some pockets of the industry still defy basic supply-and-demand logic. As long as that's the case, recovery is bound to be elusive.

Case in point: chipmakers that sell to communications-equipment outfits, arguably the most distorted and overbuilt market of the late 90s. As demand for equipment has shriveled, the pain has reverberated down to the chipmakers that supply the likes of Cisco(CSCO), Nortel(NT) and Lucent(LU). But there's been no shake-out yet among silicon vendors, and therein lies the problem.

Too many chipmakers continue to sell to a shrinking market, say industry watchers, who believe consolidation would help restore some sanity to the silicon business.

Yet communications IC outfits, bolstered by outsized egos and still holding a lot of cash thanks to lucrative IPOs, refuse to say uncle. And that means investors shouldn't expect a sustainable turnaround anytime soon in a business still struggling with excess capacity.

Short String Comm IC suppliers serve a tough market
Company	Ticker	Leading Comm Equipment Customers
Agere	AGR.a	Avaya, Cisco, Lucent
Applied Micro Circuits	AMCC	Nortel, Alcatel, Ciena, Cisco, JDS Uniphase, Juniper, Lucent, Nortel
Broadcom	BRCM	Motorola, 3Com, Cisco, Dell, Nortel
Conexant	CNXT	ADC, Alcatel, Cisco (customers of Mindspeed arm)
Exar	EXAR	Alcatel, Cisco, Tellabs
Globespan	GSPN	Lucent, Cisco
Multilink	MLTC	Cisco
PMC-Sierra	PMCS	Cisco, Lucent
Transwitch	TXCC	ADC, Alcatel, Cisco, Lucent, Nortel
Vitesse	VTSS	Alcatel, Cisco, Lucent, Nortel
Source: Company 10-Ks

Consider the bleak outlook for the industry's customers, the equipment makers. Telecom spending is on track to drop in the double digits again this year, and businesses are still reluctant to invest in networking infrastructure. Communications-equipment companies now operate at less than 50% of their capacity and demand is still falling, notes Bill Whyman, president of Precursor Group, a Washington, D.C.-based investor-side research group on tech and telecom. "That's obviously horrible news for their suppliers."

Worse, the same equipment companies that once touted products based on whiz-bang technology are now being forced to compete on price. Dell(DELL) is pushing enterprise networking products for 70% off the price of comparable gear from Cisco and Foundry(FDRY), notes Ashok Kumar, an analyst at U.S. Bancorp Piper Jaffray.

The takeaway for suppliers is bearish: Further price deflation in equipment is bound to weigh on the price of the silicon that goes into it.