Edelstone has followed the semiconductor industry at
Morgan Stanley Dean Witter
since 1997. Before that, he held a similar position at
, which he joined in 1989. Before joining Prudential, he served as a portfolio manager and market strategist for
Comprehensive Market Timing
, a company that he co-founded.
Industry Outlook and Style
A near-term negative force and a long-term positive force will place semiconductor stocks in a tug of war for at least the first half of this year. They will lurch into a nonsustainable rally at some point before dipping to a third-quarter nadir that will signal the start of a new upcycle.
That, at least, is the gospel according to No. 1 semiconductor analyst Mark Edelstone of Morgan Stanley Dean Witter.
The negative force, says Edelstone, is the continued deterioration in business fundamentals caused by the weak economy and a groupwide inventory correction. Countering that is the
Federal Reserve's easing monetary policy. However, it takes several quarters for interest rate cuts to positively affect the economy, specifically this sector, he contends.
"We've already reached the point where the average semiconductor stock doesn't have a lot more downside from the prior lows, considering that, by December, there was already so much discounting of negative news," says Edelstone. "But then again a rally in the first half -- which I predict won't reach previous high points -- will create more downside risk. More precisely, it's possible that once the rally is complete, there could be a 30% to 50% selloff, with a final low in the late second quarter or early third quarter," he continues. "In the meantime, look for a wide, choppy, trading-range environment."
Despite his fairly gloomy short-term outlook, Edelstone is counting on certain stocks to outperform the group.
One attractive segment, he thinks, consists of those companies with variable-cost business models -- that is, companies that don't have their own wafer fabrication facilities. These are known in the industry as "fabless" firms. Fabless firms' advantage is that they have less potential for excess, which can bedevil the profitability of fab companies, operating as they do on a fixed-cost business model.
All four of the stocks that Edelstone tags as likely outperformers for 2001 are fabless firms. They are
. According to the Morgan Stanley analyst, the four have strong product cycles and good pricing power.
In the first three to four weeks of the year, these four stocks spurted ahead by 51% on average. "While these gains suggest that near-term profit-taking is likely," Edelstone notes, "we continue to recommend them because we believe they will be this industry's winners this year."
Edelstone estimates that Broadcom, the leader in broadband integrated circuits, will grow revenue by 97% this year as it benefits from its existing strength in networking, cable set-top boxes and cable modems and as it expands into new market opportunities, such as optical and home networking. Broadcom's stock, which rose some 67%, to $139, between year-end and Jan. 19 (though it had lately lost all those gains), could climb to $225, according to an optimistic Edelstone.
Adds the analyst: "Broadcom has a strong management team, which is involved in significant M&A activity. In January, for instance, Broadcom acquired
for its 18th acquisition, which is a leading supplier of logic devices for input and output functions within servers. We believe Broadcom not only has one of the best-positioned product lines within the entire semiconductor industry but also will continue to expand that portfolio. Most notably, the powerful trends in the broadband integrated circuit market will benefit Broadcom, a company we view as the Intel of the current decade." (Morgan Stanley underwrote Broadcom's
IPO and secondary offering.)
Lattice is primed to enter the field programmable gate array (FPGA) market this year, which Edelstone believes will stimulate the company's long-term growth rate. "Revenues should grow 8% this year, but as the company benefits from its entry into the high-growth FPGA market, the five-year growth rate could potentially increase to 40% from prior estimates of 25% growth," he says. For this reason, he has put a price target of $50 on the stock. (MSDW managed a recent convertible offering for Lattice.)
Nvidia is gaining significant market share in the PC market, with products that for the first time address both notebook PCs and
computers, says the Morgan Stanley analyst. In addition, it is branching into new markets as a result of its design win for Xbox,
high-profile video game platform. Revenue could grow 50% this year, and the stock could zoom to $100, the analyst projects. (Edelstone's firm led Nvidia's last common stock offering.)
As for Xilinx, having the premier franchise for programmable logic -- particularly the Virtex product line -- is enabling that company to enjoy strong growth in the communications markets. Edelstone forecasts 2001 revenue growth of 25%. If that growth is met, the stock could reach $80, he projects. (MSDW has done merger and acquisition work for Xilinx.)
Favorite stock for next 12 months:
12-month target price:
"Nvidia is an exceptionally well-managed company that is erecting significant barriers to entry in its served markets. The stock will do well as the company gains share in the PC market and as it benefits from the success of Microsoft's Xbox, which Nvidia was awarded a contract to design. Xbox is Microsoft's high-profile video game platform."
Rate Their Stock Picks:
Which stock do you like best?
Niles: RF Micro Devices
Glavin: Applied Micro Circuits
Peck: Analog Devices