So far analog chips have escaped the worst of the selling that's hit PC-related semiconductors. But analog names could be cruising for a fall, too, warned a Merrill Lynch analyst in a note downgrading two leading companies,


(MXIM) - Get Maxim Integrated Products, Inc. (MXIM) Report


Linear Technology


, to a sell rating.

Analog Devices

(ADI) - Get Analog Devices, Inc. Report

was cut to a neutral rating.

In a report explaining the downgrades, analyst Joseph Osha cautioned that investors have wrongly come to view analog chipmakers as a relative safe haven among semiconductors. Analog companies are among the most profitable in chipland. Because their products tend to be proprietary and resist commoditization, they've avoided the harsh pricing battles that have slammed bottom lines in the microprocessor and memory arenas.

But Osha thinks stock prices are starting to look out of whack, especially given the likelihood that earnings estimates might have to be ratcheted down.

Despite the downgrades, ADI and Maxim both finished higher today, helped along by the broader

rally in chips. ADI tacked on 85 cents, or 3.8%, to close at $23.50, while Maxim gained 88 cents, or 3.1%, to close at $28.85. Linear was off 20 cents, or 0.8%, to $23.77.

In his note, Osha cautioned that the near-term revenue outlook for the trio is weak. His checks suggest that the normal seasonal upturn that analog companies see at the end of the third quarter is not materializing. As a result, he's pulled in earnings estimates (both for the end of 2002 and 2003) to reflect lower growth expectations.

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Having initially forecast fourth-quarter revenue growth of 5% for ADI, LLTC and MXIM, he now expects average growth of 1%. That outlook is more in line with comments from

National Semiconductor


, an analog company that warned earlier in the week that its revenue would be flat to down in the November quarter.

It's worth noting that despite the bad news from NSM, one of the biggest analog players of all,

Texas Instruments

(TXN) - Get Texas Instruments Incorporated Report

, affirmed guidance Wednesday for 5% sequential revenues growth.

But for the most part, the analog companies are looking more vulnerable, and as a result, more expensive at current levels. Linear and Maxim both trade at high-20s multiples of Merrill's 2003 earnings estimates, well above their trough levels. "In an environment in which earnings estimates are more likely to be revised down than up (especially for the fourth quarter), that is a recipe for a sharp downward adjustment in stock prices," he wrote in a research note.

By comparison, Analog looks less expensive both in absolute and historical terms. For that reason, and because the company has improved its cost controls, Osha downgraded it to neutral instead of sell, as he did with Linear and Maxim. Merrill hasn't done recent banking for any of the three companies.

Osha points to Texas Instruments by way of a cautionary example. "We remember watching investors 'hide out' in Texas Instruments earlier this year, which was trading on a similarly high 2003 earnings multiple and had similar questions surrounding the visibility of the earnings estimates," he recounts. Then a fairly small adjustment to its earnings outlook triggered a painful 20% decline in the stock price.

Both Linear and Maxim run a similar risk over the next several months, Osha believes.

Outside of Merrill, the view on analog chips is mixed. On Friday, Prudential analyst Hans Mosesmann cut estimates for Maxim and Linear, citing a lower-than-expected seasonal rebound in PCs and continued lack of visibility in other end-markets. But Mosesmann kept a buy rating on both, characterizing them as defensive technology plays.

Banc of America's Doug Lee has recently gone on record

praising the profit margins of analog names but steering clear because of their high prices. Yet in mid-August, Lehman Brothers upgraded the same trio that Merrill downgraded, saying prices had fallen enough to make them decent values.

In any case, while the valuation debate will no doubt continue, it's becoming clear that analog names look susceptible if the second half continues in the weaker-than-expected vein.