What to do when chips are down

September 24, 2006|By James P. Miller | James P. Miller,Chicago Tribune

A summer sell-off in the volatile semiconductor group has raised an interesting question for investors: If the chips are down this much, is it time to buy?

Although semiconductor stocks have underperformed the broader market since May, in recent weeks the market appears to be regaining an appetite for the group. Shares of computer chip-makers such as Intel Corp., Advanced Micro Devices Inc. and National Semiconductor Corp. have not only halted their nose dive but also regained a good portion of the ground they lost.

A number of experts are suggesting that chip-industry investors overreacted to recent evidence of the economy's slowdown. And by doing so, they say, the sell-off may have created some opportunities in individual chip stocks, or in exchange-traded funds based on semiconductor-makers.

`A bit too negative'

Overall, the market has "probably been a bit too negative" on the chip sector during the summer months, Needham & Co. analyst Charlie Glavin said. Needham is "cautiously optimistic" on the sector, Glavin said, and while chip stocks as a whole are not cheap, a number have been oversold and "we're telling people to buy if they can find opportunities and be selective."

The upside potential hasn't escaped private-equity investors, even though they have long avoided chip companies because of the sector's substantial swings in profitability. Earlier this month, a leveraged-buyout group agreed to pay $17.6 billion to acquire Freescale Semiconductor Inc. in what not only is the tech world's biggest-ever LBO, but also is evidence that deep-pocketed investors are cruising the chip world in search of bargains.

A number of observers still fret about the increase in the inventory of unsold chips on hand, however, and the question of whether the buildup is evidence of eroding fundamentals or a temporary slippage has yet to be answered.

Chip stocks may be moving away from their reputation as a sector that's not for the faint of heart. A recent trend toward outsourcing of production has helped trim the industry's lowest lows, but also its highest highs.

More significantly, as computer chips penetrate ever deeper into consumers' everyday lives, companies' revenue streams are becoming more stable, more predictable, and, as a result, appealing to a broader group of investors.

Investors also are looking at companies that supply the chip industry, both as investing vehicles and as a source of clues about demand for chips.

Chip stocks jumped this month, for example, after Credit Suisse First Boston analysts upgraded companies that manufacture semiconductor-making equipment. Chip-makers' need for such "fabrication" equipment is strengthening in part because demand for memory chips is proving more robust than expected, according to the report.

Some companies are looking to become leaner.

This month Intel - which is locked in a scorched-earth competition for market share with archrival Advanced Micro Devices - disclosed plans to eliminate more than 10,000 jobs as part of an efficiency plan aimed at reducing expenses by $2 billion in the coming year.

Experts cannot agree whether the shake-up is evidence that the nation's leading chip-maker is floundering or that the Silicon Valley icon is getting back in fighting trim.

Sector rebound

The tech sector as a whole has enjoyed a rebound, said Jack Ablin, chief investment officer at Harris Bank, but Harris still rates the group "unattractive" for investors. Tech is not only sensitive to the economy, noted Ablin, but its players "enjoy no pricing power." Tech shares "have become the yin and yang of the stock market," Ablin suggested, with the one falling when the other rises.

The gains of the tech sector during the past six weeks, and of the chip sector that is a key component of tech, he said, very likely "reflect the energy decline," rather than strengthening tech fundamentals.

"I'm going to need more evidence before I decide this move by tech is for real," Ablin said, though he concedes that the sector is likely to strengthen by early next year.

For an investor the computer-chip world can be daunting, with its obscure acronyms, its history of overpromising, and its perpetual obsession with the next big thing. Even highly successful chip products have relatively short life spans before they become obsolete, and industry players must perpetually pour money into product development.

At a fundamental level, however, the chip industry can be seen as a cyclical play, with its fortunes tracking the rise and fall of the broader economy.

Chips are deeply embedded in most aspects of modern life, from consumer electronics to transportation and heavy manufacturing. That has rendered the sector increasingly economically sensitive. Chip stocks are affected much more than they once were by real-world factors such as interest rates, the strength of the auto market, consumer debt levels and even the success of retailers' holiday seasons.

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