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From Business Week::

MARCH 28, 2000

What Keeps Powering Chip Stocks
Chase H&Q's Sudeep Balain on how to play the semiconductor hot streak

News Flash Archive

We are going to continue to see money pouring into the semiconductor sector, says Sudeep Balain, senior technology analyst for Chase H&Q. Growth in this area is being driven primarily by the acceleration in wireless communications, and also by increased Internet usage and the proliferation of digital consumer products. Companies like LSI Logic, Atmel, and Xicor are benefiting from the move toward wireless communications, according to Balain.

In a chat hosted by Business Week Online on America Online on Mar. 23, Balain discussed the most underrated semiconductor stocks, prospects for intellectual-property companies, and the competition between Intel and AMD, along with industry trends and company fundamentals. Here's an edited transcript of Balain's answers to questions from the online audience and from Business Week Online moderator Jack Dierdorff.

Q: It was another wild day on Wall Street. How long do you think the market can stay on this high wire? Or don't you see it as a high wire?
A: My sense is that as we move forward, we are going to see days with this kind of volatility. You'll see money move in and out of the Dow and the Nasdaq. There are more and more people investing in the market today, and because of that you are going to see more volatility -- and we just have to get used to it.

Q: Are the semiconductor stocks still going to share in the glory?
A: Absolutely. I think moving forward you are going to continue to see money going into the semiconductor sector -- principally going into companies that are in the areas of microprocessors, micro controllers, ASICs [application-specific integrated circuits], and nonvolatile memory companies. These are all specialized semiconductor companies, which are seeing growth being driven by the acceleration in wireless communications, increased Internet usage, and the proliferation of digital consumer gadgets all around us.

Q: Do you think that Intel is still in the same dominant market position that it held in the past -- or is it starting to lose its leadership?
A: I think Intel is in the same position of market dominance, but its focus is changing. It is moving away from only being a company that is the primary building-block supplier to the PC industry to being the preeminent building-block supplier enabling the worldwide Internet economy.

Q: Which major chip companies do you cover? Which ones offer the best upside potential?
A: I currently cover Intel, Advanced Micro Devices, LSI Logic, STMicroelectronics, Xilinx, Altera, Atmel, and Microchip. Within these companies I cover today, I would put fresh money into AMD, Intel, Microchip, and LSI Logic at current prices.

Q: Advanced Micro Devices seems to be perpetually on the verge of making a run at challenging Intel, yet they never quite get it together. Now they're beating Intel's pants off in terms of technology. Will they have the same manufacturing problems that snagged them in the last cycle?
A: We believe this time around things are very different for AMD. For the first time in its history, the company has the microprocessor products to effectively compete across both the "value" and "performance" segments within the PC industry, with its largest competitor Intel. We think that AMD now has microprocessor products as good or better than Intel's, and we think the company can effectively compete with Intel moving forward.

AMD is also doing extremely well with their flash products. We think it is working behind the scenes to lock in substantial amounts of demand for high-density flash products from its current customers. We are expecting a flurry of new announcements in the next six to nine months in this regard. These customer agreements will be similar to the ones that the company recently signed with Cisco and Samsung, wherein AMD will be supplying flash products worth $400 million to $450 million to both these companies over the next three years. We like the story very much. Our short-term target price is 85.

Q: Any suggestions on chipmakers that stand to benefit most from the move to wireless?
A: LSI Logic, STMicroelectronics, and Atmel are three companies that will continue to benefit from the move toward wireless. I don't currently cover Xicor, but I think it will also continue to benefit from the trend.

Q: What did you think of Micron Technology and its latest earnings? Would you buy this stock?
A: Micron's earnings were lower than expected mostly because of lower ASPs [average selling prices] during the quarter. We believe that stronger demand in the second half will again result in shortages of DRAMs [dynamic random-access memory chips] that will lead to price recovery.

In addition, the deployment of the Windows 2000 operating system during the second half of this year will require faster processors and more memory moving forward in PCs. For example, a PC with Windows 2000 requires an additional 2.5 times more DRAM memory than one with Windows 98. We believe moving forward, microprocessor companies like Intel and AMD and DRAM companies like Micron will benefit from this trend.

Q: What's your opinion on Applied Micro Circuits, RF Micro Devices, and PMC Sierra?
A: These three companies will continue to benefit from the increased need for more bandwidth moving forward. These stocks are not cheap in terms of valuations, but we believe they will continue to go higher moving forward. The current primary driver of semiconductor growth, we believe, in this cycle is wireless communications. All of these three companies in one way or another play into that theme.

Q: Do you think intellectual-property companies like Rambus and Qualcomm will continue coming out with new patents, or are they going to exist for the next 75 years on just their current ideas?
A: We like both of these companies, especially Qualcomm, in terms of their IP patent portfolios. I think both companies will continue to come up with new patents. We like Qualcomm because of the acceleration in wireless communications. The usage of cellular phones continues to explode, from about 375 million sold worldwide this year to more than 1 billion phones sold in 2003. The primary emerging standard of those phones is CDMA technology, and Qualcomm is the leader, far ahead of everybody else in the patent portfolios of CDMA technology.

Rambus develops and licenses high-bandwidth chip-connection technologies to enhance performance of computers and consumer products. Over the years, as the speed of the processor within a system like a PC has grown astronomically, the rest of the semiconductor components, like DRAMs, have not kept pace. Rambus changes all that. The company owns patented licenses in speeding the conversations between the processor and the associated chips within the PC, like DRAMs. We believe Rambus will continue to increase its patented portfolio position.

Q: What about Atmel?
A: We like Atmel's story. The stock has had a huge run in the last two months and has gone beyond our current price target of 50. We are hearing that the current quarter is on track and expect the company to come out and beat our current-quarter EPS estimate of 18 cents. Atmel's primary growth drivers are serial EEPROMs (electronically erasable programmable read-only memory), flash, and ASIC devices that the company supplies to leading cellular-phone manufacturers like Nokia, Ericsson, Motorola, and many Japanese customers. We think the story will continue to work.

Q: What is the most underrated semiconductor stock out there?
A: There are two in my opinion, AMD and Xicor. I've already talked about AMD. Let me comment on Xicor. The company is transforming itself away from being a semiconductor manufacturer to a semiconductor company that solely focuses on designing, marketing, and selling new products. They are gradually moving all of their manufacturing to foundries such as Yamaha in Japan and ZMD in Germany.

We believe as much as 40% of Xicor's revenues could come from cheaper foundry wafers in the current quarter. The company also at some point will successfully sell its current fab in California. In addition, a lot of the growth drivers of Xicor are similar to Atmel, in that they supply products to the wireless-communications industry and a lot of the additional consumer products such as set-top boxes, pagers, etc. We think the company can do at least $1.15 EPS in fiscal '01. If we give them at least a 30 p-e multiple, it gets us to a $35 price target. The stock is currently trading at around 17 or 18. So we believe the company's stock is grossly undervalued.

Q: Do you think Cisco can sustain their growth?
A: I don't cover the stock, but I do cover a lot of semiconductor stocks that sell to Cisco, like AMD, LSI Logic, and Intel. If you believe that the Internet is here to stay and will continue to explode in terms of usage, you have to believe that companies like Cisco, who are the primary suppliers of networking boxes that are the backbone of the Internet, will continue to grow. The stock is not cheap in terms of valuation, but in our opinion should be a core holding in a tech portfolio.

Q: Is the book-to-bill ratio still a sufficient way to measure the demand for semiconductors in today's economy?
A: Yes and no. The book-to-bill gives you the general macro in the semiconductor industry. One needs to drill down into each company's booking and billing growth rates, in our opinion, to get a better picture of the company's prospects. It is not sufficient, in our opinion, to buy a semiconductor company just because the book-to-bill is strong.


Copyright 2000, by The McGraw-Hill Companies Inc. All rights reserved.
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