Is the Recovery Real?

The second half of 2002 is here, so where is the recovery?

If one were to take a cue from Wall Street, it is still a long way off—say 2003. As the industry heads into earnings season and Semicon West, which begins Wednesday, tech stocks continue to plummet. Financial analysts, after touting signs of recovery and raising buy ratings throughout the spring, have done a 180-degree turn.

Wall Street has pulled heavy on the reins, placing blame on everything from reported problems with chipmakers' ramp of 0.13-micron processes to order digestion, a lack of end-demand and pushouts of 300mm fab plans.

"While Q2 results will be strong and Q3 order guidance will likely call for 5 percent to 15 percent sequential growth, the bigger question that seems to be lurking is what Q3 results will actually be and whether or not orders will be flat or down in Q4," said Goldman Sachs and Co. analysts James Covello and Amanda Hindlian in a recent research note.

"It appears that the risk to flat or down orders in Q4 has increased significantly since we first highlighted the possibility in our downgrade of the sector at the end of May, as potential weakness at the foundries is supported by slowing wafer-start activity and weakness in the PC supply chain," Covello and Hindlian wrote.

Investors, and by association the companies' stocks they buy and sell, are paying the price for Wall Street's glowing reports of recovery early in the year, said Ron Leckie, CEO and research director of market research firm Infrastructure.

Equipment order growth in the first half wasn't a recovery so much as a rebound to the underlying level of demand for chips, which has remained essentially flat, Leckie suggested. "We had been running below that as the inventory was bleeding off," he said.

While consumer spending has remained relatively strong, the entire industry as well as Wall Street is looking for business IT spending to pick up and carry it beyond the modest improvements of the first half.

This has begun to happen in small fits and starts, said Jim Morgan, CEO of Applied Materials Inc., in a recent interview with Electronic News. But most large business and industrial IT customers haven't upgraded their IT infrastructure since 1999, when everyone was preparing for Y2K, Morgan said.

In technology time, that's an eon.

"It's the upgrades for the business world that really need to happen," Leckie said. "It's [corporate IT infrastructure] getting old, when you think about it."

While the technology industry looks to the corporate world to carry it out of the downturn, some Wall Street watchers have observed that investors are also dumping stocks because of eroding public confidence in corporate America's accounting practices—a la WorldCom—and before it, Enron.

"It definitely is. It's infecting all of the stocks," Leckie said, adding that investor confidence is the lowest he has ever seen it. "Last year any news was good news; now any news is bad news," he said of investor reactions.

Industry Analysts: Don't Give Up Hope

While Wall Street and the news wires may be filled with financial gloom and doom, evidence continues to trickle in that the industry and its supply chain may be recovering from 2001, albeit slowly, painfully and cautiously.

VLSI Research Inc.'s Chip Price Performance Index rose 0.6 points at the end of June, the first rise in more than a month, with prices for both DRAMs and CPUs increasing.

"Overall, the effect of chipmakers' recent backing off their capacity throttles is turning out to be an immediate gain in pricing traction. So, underlying demand remains healthy," according to a recent statement from VLSI.

"The data shows … that there has been an under investment in production equipment," said VLSI VP Risto Puhakka, even as chip inventories may still have a little bit of room to drop even further.

Thus, even as 2002 as a whole may still prove negative in terms of growth, there is still room for sequential order growth in calendar Q3 and Q4, as opposed to flat or negative growth that some financial analysts are predicting. "We've spent quite a bit of time [researching that] … we definitely think that's not the case," Puhakka said.

Technology buys and leading edge capacity are still strong market segments—in particular process diagnostics and 193nm lithography. "There is a good chance that the whole market doubles this year," Puhakka said of the 193nm tool market. "It's the leading edge stuff … taking the bulk of the crop."

At market research firm Gartner Dataquest, there is guarded optimism for the semiconductor industry and the second half of 2002, noted senior chip equipment analyst Dean Freeman. Dataquest will be presenting industry forecasts on the last day of the show, July 24, in San Francisco.

There are technology and 300mm buys going on; however, Q2 and Q3 could prove flat going into Q4, Freeman said. "The overall capacity purchases really aren't happening," he explained. Furthermore, summer and Q3 are traditional slow periods for chip sales and, consequently, the industry, he added.

In any event, despite the Street'sworries, the 0.13-micron ramp appears to be underway, and the reports of problems don't appear to extend beyond those normally associated with the ramp of a new technology node.

As Applied's Morgan has noted before, while the bulk of current chip designs is at 0.13-micron design rules, only as little as 6 percent of the world's chip capacity is capable of 0.13 micron.

"I think there could be a shortage, technically," Morgan said.

As for what Wall Street will do in the coming weeks, it will no doubt take its cue from Semicon West.

In addition to the typical trade show buzz, West falls smack in the middle of earnings season and a number of equipment companies will report quarterly results during the show—results that will no doubt be scrutinized by investors.

Among companies reporting over the next couple of weeks are Novellus, Lam Research, Asyst, Cymer, Varian Semiconductor, ATMI and PDF Solutions.