Hitting bottom may actually feel like a relief for the beleaguered chip-equipment industry, given its painful, slow-motion fall over the past six months or so. Some industry watchers have already predicted the group will hit a trough in the fourth quarter now under way, based on lousy order expectations.

But despite the drop, investors shouldn't expect a big snapback. With the exception of a few maverick optimists, most analysts say that after two thoroughly crummy years in a row, 2003 is still not likely to show an impressive turnaround.

"I don't think next year's going to be stellar year in terms of industry fundamentals," said Wells Fargo's Susan Crossley. The reason, she explains, is that despite expectations for anemic chip growth this year, the top 10 semiconductor outfits didn't pare back their spending at all. In fact, they spent about 22% of projected '02 revenues on equipment -- about on par with the historical average.

"That says to me that this year, as bad as it was for the equipment industry, didn't do much towards working off the spending hangover," says Crossley. "That tells me that next year is not going to be a barnburner in terms of industry growth."

The official voice of the chip-equipment industry, the trade group SEMI, predicted earlier this month that equipment sales will grow 15% in 2003, to $21.8 billion from this year's $18.9 billion. That outlook assumes that by the second half of next year, semiconductor inventories will be burned off and manufacturing capacity utilization will be on the upswing.

But take it with a grain of salt, because industry forecasts are notoriously prone to revisions. Last year at this time SEMI forecast that 2002 sales would be flat to slightly down. Yet in the past week, it said revenues are likely to end down 32% for the year, following an even worse 41% tanking in 2001.

In line with the harsh drop-off, chipmakers' capital spending budgets remain a shadow of their former selves. For spending to return to its 2000 peak of $64 billion by 2005, Morgan Stanley's Steve Pelayo reckons budgets would have to post successive year-on-year increases on par with those seen in 1999 and 2000, when spending ballooned 30% and 75%, respectively. That's hardly likely right now.

In fact, he expects semiconductor capital spending to eke out a mere 2% gain next year.

Equipment names are "discounting too much, too soon in terms of the muted recovery outlook," says Pelayo, who recently cut his rating on the industry from attractive to market-perform. "There's such a bubble behind us; we were firing on all cylinders. But it will be difficult to get all the stars to line up next year."

Still, after what's likely to be a sluggish beginning of the year, some analysts expect equipment sales to gain momentum later on.

Lehman's Edward White thinks the industry could end up posting growth of 10%, possibly helped along by demand for state-of-the-art chips with tiny transistors that are spaced only 130 nanometers apart. (One nanometer equals one billionth of a meter). These devices, used in laptops and cell phones with color screens and cameras, allow a single chip to combine different functions and use less battery power.

"It doesn't take tremendous growth to require more equipment investment if the growth is in leading edge products," says White, pointing to a limited manufacturing capacity for those products, which account for only about 8% of current production. "If demand comes in for products that require finer linewidth chips, there could be a scramble for manufacturing capacity. If we get even 6% growth in PCs and about 8% in digital cell phones, that's consistent with about 10% growth in the semiconductor capital equipment industry."

Despite the prevailing mood of caution on chip equipment, there are a few outright optimists.

Take Nick Tishchenko, an analyst at Fulcrum Global Partners. For next year, he's betting on chip growth of over 20%, with equipment likely to post revenue gains in the range of 15% to 20%.

Tishchenko bases his outlook on the International Monetary Fund's forecast for global GDP growth of around 3.7%, pointing out that semiconductor growth has historically been tied to that figure. Meanwhile, inventory levels are at historic lows, he says. "There is no buffer. The very first response of the market to shortages would be a spike in average selling prices for not just the more advanced, but also commodity products," he says.

He offers flash memory as a case in point. Intel ( INTC) recently announced it will boost its selling prices for flash by up to 40% next year. "Usually this is the sign of the coming upturn when there are shortages developing in the market, whether it's flash or DRAM," says Tishchenko.

Whatever pans out, one thing is certain: Any orders growth for equipment will be a welcome change, especially with the current quarter expected to show double-digit declines for leading names. Industry bellwether Applied Materials ( AMAT), for example, has guided for an orders drop-off of 20%.

As of October, the book-to-bill ratio, a measure that reflects industry orders relative to billings, had shrunk for five months in a row.

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