Communications Chip Stocks Humbled by Nortel Warning

Thank Nortel (NT) for finally making clear what investors should have known already: It's still too soon to buy communication chip stocks.

Nortel on Thursday evening followed up on earlier warnings from communications-gear giants Cisco (CSCO) and Lucent (LU) with its own downcast take. The networking equipment company halved its 2001 growth forecast, saying it is seeing a faster and more severe economic downturn than anticipated.

That's bad news for the chip and component companies that are dependent on orders from Nortel to fuel a significant part of their networking business, namely Applied Micro Circuits (AMCC), Corning (GLW) and JDS Uniphase (JDSU). Xilinx (XLNX), Altera (ALTR) and PMC-Sierra (PMCS) also derive significant revenue by making chips that are used in Nortel's transport boxes, which essentially move data. All five companies' stocks were taking it hard Friday, giving up some of the ground they had gained during the past week as some investors began contemplating that the decline in demand for chips had bottomed out.

Past Is Prologue

Semiconductor growth has contracted in the past six months as end markets, including those for personal computers, cellular phones and communications, have suffered from inventory buildup and slowing demand. During the past month, many companies have discussed the difficult business climate of late last year as well as their expectations for a weak first half. For example, a Feb. 6 announcement from Cisco drove shares in supplier PMC-Sierra down sharply. But Cisco and other companies have also leaned heavily on the notion of a recovery in the second half. Nortel changed all that -- at least for the communication companies.

Lehman Brothers analyst Dan Niles said in a research note Friday that the inventory purge going on at Nortel will last longer than its semiconductor suppliers had been led to believe. In the note -- titled "And It Will Get Worse From Here" -- Niles said Applied Micro Circuits and JDS Uniphase are also at risk because of Nortel's comments about customers pushing out purchases of some transport-related optical systems into the second half. (At the moment, Nortel's problems have more to do with its nonoptical sales.)

Lehman hasn't done any underwriting for any of the companies mentioned in this story.

Big Chunk

According to a filing with the Securities and Exchange Commission, Nortel and its distributors accounted for 18% of Applied Micro Circuits' $143.3 million in sales during the December-end quarter. That's less than half of the 40% Nortel accounted for in the year-earlier quarter and also down from the 23% it has averaged in the nine months ended December 2000. But Nortel is still Applied Micro Circuits' biggest account outside of distributors, followed by Cisco, which provided 10% of sales in the most recent quarter.

That's why the Nortel news has hit Applied Micro so hard. But the San Diego chip maker isn't alone. According to Lehman Brothers, Nortel brings in 15% of JDS Uniphase's business and about 7% of sales at both Xilinx and Altera, two of the biggest producers of programmable logic devices, or PLDs.

PMC Sierra was off $4.88, or 8%, at $53; JDS Uniphase was down $8.38, or 18%, at $36.75; Applied Micro Circuits was down $7.06, or 14%, at $44.63; Xilinx was down $4.88, or 9%, to $49.13; and Altera was off $3.06, or 10%, at $27.69.

All this promises that the first-quarter earnings period is going to be another rocky one for communication stocks. Prudential Securities analyst Hans Mosesmann on Friday cut revenues and earnings estimates on Altera and Xilinx, saying that in a recent meeting, a Xilinx executive said visibility for 2001 remained low. Prudential hasn't done any underwriting for Altera or Xilinx. The telecommunications spending slowdown -- of which Nortel is just one piece -- will continue to weigh on these companies, he says.

No argument there.

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