Shares of leading foundries Taiwan Semiconductor ( TSM) and United Microelectronics ( UMC - Get Report) took a hit after an investment bank slapped a sell rating on both stocks, downgrading them from hold. On a day in which many tech stocks slid into the red, the foundries saw especially heavy selling. Taiwan Semi lost 60 cents or 8.1% to $6.80, while UMC was off 25 cents or 7.6% to $3.03. The broader chip index fell less steeply, down 4.2%. Deutsche Bank said it believes the foundries "will undergo a structural reduction in profitability even as sales increase." Foundries manufacture computer chips for semiconductor companies, which have increasingly turned to outsourcing as a means to cut costs. Among the so-called "fabless" semiconductor companies that outsource manufacturing are Qualcomm ( QCOM - Get Report), Nvidia ( NVDA - Get Report) and Broadcom ( BRCM). Early in 2002, TSM and UMC enjoyed a surge in popularity among fund managers who figured they would benefit from the long-term trend towards outsourcing. But as the outlook for chip growth has been repeatedly curtailed, their stocks have plummeted. Since their respective peaks in March and April of 2002, shares of TSM have shrunk 59%, on the basis of Friday's close of $7.40, while UMC has dived 67% to $3.28. Among the negative trends likely to weigh on the foundries, the Deutsche note points to the increasing complexity of chip designs and production, a slower migration to new technologies and increasing competition, which will weigh on prices. Deutsche Bank has banking relationships with both Taiwan Semiconductor and United Microelectronics. And while the foundries have lately seen some short-term strength, Deutsche says it doesn't reflect a resumption of sustainable growth. "The recent strength in wafer loading seen at TSMC and UMC can be attributed to inventory restocking only and not real demand," writes analyst Kishore Suratkal. "Intel's marketing push for Centrino
is driving new graphics processors and start-of-the-year product launches of new function phones has resulted in an order loading rush. "This we expect to taper off beyond the second quarter of 2003, resulting in stagnant utilizations for the rest of the year," he said.