Communication chipmakers have been complaining for months that visibility is limited. But if they'd just look two steps away, at their customers' customers, the view would be much clearer.

In the past week, telecommunications service providers like

WorldCom

(WCOM)

have cut back on their capital spending plans for 2001. In turn, that'll lead to fewer orders for telecom equipment from the likes of

Cisco

(CSCO) - Get Report

, which means less demand for the chips that go into them. Most telecom service providers already cut their spending plans this year, pushing them below last year's levels, but these cuts create an even dimmer outlook. Telecom spending is forecast to be $5.5 billion less in 2001 than originally planned.

For the communication chipmakers, this could lead to weaker revenue, earnings and stocks. And while the stocks have tumbled over the past year, they remain at relatively high valuations, reflecting little of these new spending cuts.

For most of 2000, communication chip makers including

PMC-Sierra

(PMCS)

,

Applied Micro Circuits

(AMCC)

and

Vitesse

(VTSS)

rode the telecom spending spree to staggering profits.

But things began to turn in the latter half of 2000 as the easy money to fund expansions dried up and the build-out slowed. Cisco, for instance, found itself with warehouses full of inventory, nearly erasing its need for more supplies. Communication chip companies found their own inventories swelling.

Now executives at these companies hope that business will turn around sometime in the second half of 2001, but it's becoming clearer that hope includes a lot of wishful thinking. PMC-Sierra, Applied Micro Circuits and Vitesse weren't immediately available to comment.

Get In Line

Here's how the supply chain works. International telecom company

360networks

(TSIX)

cut its 2001 budget by 38%, or $1.45 billion, to $2.3 billion last week. Supplier and optical networking gearmaker

Sycamore

(SCMR)

turned around and cut its revenue target by 36%. One step further would've brought investors to the outlook for Applied Micro Circuits, which lists Sycamore among its customers.

In another example,

Sprint

(FON)

trimmed $300 million off its spending budget for this year. Its suppliers include Cisco,

Lucent

(LU)

and

Nortel

(NT)

, all of which turn to Applied Micro Circuits, Vitesse and PMC-Sierra for communications chips.

Some analysts on Wall Street are noticing how the problems in the telecom sector could hold back communication chip companies. Last week,

Lehman Brothers

upgraded communications chip makers that supply the cable modem and corporate networking markets, including

Broadcom,

(BRCM)

, but kept suppliers of telecom service oriented companies like Applied Micro Circuits, PMC-Sierra and Vitesse at market perform. (Lehman hasn't done underwriting for these companies.) On Tuesday,

Prudential Securities

maintained its hold rating on PMC-Sierra, citing concerns about inventories and service provider debt levels and bankruptcies. (Prudential hasn't done underwriting for PMC-Sierra.)

But investors aren't necessarily paying attention. Communication chip stocks have remained on the same upward path they've been on for months, fueled by investor optimism that the worse is over for semiconductors. The announcements from Sprint and 360networks weighed on their own stocks and for a time on the likes of

Alcatel

(ALA)

, Nortel and Cisco. But since then the telecom equipment makers have gotten caught up in a wave of optimism and both they and the semiconductors have climbed higher.

Since the beginning of last week, Sprint has fallen 6% and 360networks has dipped 31%. Alcatel, which has its own problems related to the possibility of its bid for Lucent, is off 3.5%; Nortel is up 6.6% however and Cisco has gained more than 20%. PMC-Sierra is up 9%, Applied Micro is up 15% and Vitesse is 13% higher.

In April, as these companies' executives reported on first-quarter earnings, PMC-Sierra, Applied Micro and Vitesse talked about the lack of visibility from their customers and about not knowing much more besides that order cancellations and push-outs would continue.

But from what their customers' customers are doing, it looks like 2001 could still get worse.