Microchip Technology

(MCHP) - Get Report

became the first chip company to cite the epidemic of severe acute respiratory syndrome disease, or SARS, as one of the causes of a drop-off in business.

The company made the remarks Monday in a statement lowering estimates for its just-ended fourth quarter.

The epidemic of the pneumonialike disease could further undermine the already fragile outlook for U.S. semiconductor companies. A note released by First Albany on Monday said SARS' effect could slow the pace of sales and depress consumer demand in China, weighing down earnings in the second and third quarters.

Auguste Richard, a First Albany analyst, dramatically slashed his chip-revenue growth estimate for 2003 from 8% to zero, saying the impact of SARS will be larger than that of the war in Iraq. There's a possibility that sales could dip into the red on a year-over-year basis, ebbing 5% from last year's levels, he added.

Richard is the first Wall Street analyst to pinpoint SARS as a major threat to technology outfits, and he holds unusually bearish views on the likely financial toll of the disease. But even those with a less-gloomy take say the SARS risk deserves more attention.

"I don't think equity valuations have priced in the risk" of SARS, says one hedge fund analyst. "SARS is really hitting the regions of major importance to technology. I think the war coverage has been drowning that out."

Lending further weight to Richard's comments, on the same day he issued the note, semiconductor outfit Microchip warned on sales and earnings for the second time in three weeks. The company said fallout from SARS is hurting business. In Microchip's view, SARS has given customers one more reason to delay purchases, though the firm primarily blames the war in Iraq and the economy for slackening demand.

CEO Steve Sanghi, in a statement, said the spread of SARS "is inhibiting business travel and, in some cases, purchasing decisions, as many customers are temporarily closing plants to avoid the spread of the disease."

Besides the obvious health threat, SARS poses a financial risk because Asia looms so large in both manufacturing and in consumption of semiconductors and chip equipment. On the supply side, the region produces as much as 40% of the world's semiconductors and between 70% to 90% of PCs.

The illness already has made it trickier for technology companies to close sales deals, because many have sharply curtailed travel to Asia. In some cases, it has affected productivity even more directly:

Motorola

(MOT)

briefly closed a manufacturing facility in Singapore after an employee came down with SARS, and both

Intel

(INTC) - Get Report

and

Hewlett-Packard

(HPQ) - Get Report

have shut offices in Hong Kong and sent workers home on SARS-related concerns.

"There's likely a supply-chain disruption ... people and goods can't move in and out of the region easily anymore," Richard said.

On the demand side, China is the world's biggest consumer of cell phones and the No. 2 buyer of PCs. "End demand in China is already slowing," wrote Richard, noting that "more and more reports are surfacing that shopping malls and restaurants are empty in the region."

Cell-phone sales in Asia started to dip several weeks ago, around the same time news reports about SARS started to circulate.

"We've definitely seen a weakening of demand coming out of Asia in terms of the consumer," says Woody Calleri, an analyst at Midwest Research, which recently conducted surveys on demand in Singapore, Hong Kong, Taiwan and China.

Although cell-phone sales had been expected to be flat to up slightly in the first quarter, they fell 5% to 10%. The sales dip, Calleri added, "hit mostly in the middle of March into April. A lot of the people at cell-phone outlets thought consumers had become less willing to go out to crowded areas."

As of Monday, the World Health Organization reported a worldwide total of 2,601 SARS cases. Almost half, or 1,268 cases, have occurred in China, which has absorbed 53 of the 98 worldwide SARS deaths.

For now, perhaps the biggest question is how soon the spread of SARS can be curtailed. "If it clears up in the next quarter or so, maybe growth doesn't go from 8% to 0%; maybe it goes from 8% to 5%," says Richard.

SARS' Uncertain Impact

But while other analysts likewise view SARS as a potential troublemaker, few identify it as one of their leading worries. "I think local residents

in Asia are definitely very concerned, but the semi companies in general seem to be in good shape," says Jim Liang of Pacific Growth Equities. "Some have inventories they can still ship, so at this point we have not detected any noticeable disruption from supplies."

The biggest challenge for chipmakers, in Liang's view, continues to be weak end markets. He characterizes SARS as "more of a perturbation" than a primary cause for concern.

Others say it's too early to assess the likely effect of SARS. For that matter, Paul Matthews, head of the Matthews Funds, which offers mutual funds that invest in China and Southeast Asia, declined to comment for this story.

The SARS scare should have little impact on tech companies in the first quarter, notes analyst Manoj Nadkarni of Chipinvestor.com. "This is happening at a time when most companies have already closed on the March quarter," he points out.

The takeaway, though, is that SARS adds further uncertainties into a market already facing a cloudy macroeconomic outlook and war jitters. "In any environment, the worst thing for stocks is uncertainty," says Richard. "I think this just throws up a huge unknown for folks."