Whipsaw

Back and forth we go. First down and then up. Maybe we'll go back down. Maybe we'll keep going up. There's no rhyme, no real reason. If you have money in the stock market, you surely have scars from the teeth of the whipsaw. The market is doing what it does best — frustrate the most.

I probably do not have to mention that the whipsaw is also working its way through the semiconductor industry. It's a tough environment for everyone.

I've mentioned in this column my concern about the valuations, and why I think we need to be very conservative in our application of capital. A while back I put up a chart that highlighted what I thought was an inflection point in the semiconductor business. Just this week, Jim Morgan, chairman of Applied Materials, had this to say during Applied's earnings conference call: "The environment isn't going to get easier anytime soon. We continue to wait for an inflection point in the semiconductor industry."

Frankly, I think the inflection point is behind us.

Why do I feel this way? There are several reasons. In the past, feature size reductions and transitions to larger wafers were the primary elements driving the industry's profitability. During the late '90s and into the early years of this decade, we are starting to see that large-scale migrations to smaller features do not necessarily mean chipmakers and equipment companies rake in the big bucks. The transition to 300 mm wafers, once heralded as the gateway to another boom, is proving to be a place where few manufacturers dare venture. There are only a handful of players with the financial means to make the large-wafer transition. There are only a few that can push the process technology node to even smaller, sub-0.10 µm feature sizes.

Do you care whether or not the devices that power your electronic goods are made on 300 mm wafers or with sub-0.10 µm feature sizes? If they fulfill the functionality requirement I couldn't care less.

What about the inflection point? The inflection point in the chart I put in this column showed the convergence of three markets — the electronic end equipment market, the semiconductor industry and the capital equipment business. The end markets have historically grown at a high single-digit rate. Over the past 10 years the semiconductor business has come close to mirroring that growth rate, even though the long-term growth rate for the chip business is about 18% per year. The equipment companies have grown faster, at better than 20% per year.

The inflection point that I see is that future growth rates in the semiconductor and semiconductor equipment business will more closely track the growth rate of the end markets. If this happens, it means that business models must be adjusted to fit this growth curve. This means that we, as investors, must fine-tune our valuation parameters.

While some in the industry will say that reality has hit home and companies are already embracing this theme, I am not sure if investors are seeing the light. I see a long period of adjustment ahead. Rick Hill, chairman and CEO of Novellus Systems, asked what I consider to be "the question" in front of an audience attending the recent International Trade Partners Conference. "Will we ever make any money at this?"

I'd like to answer Rick's question with a "yes," but we need to see some results. Given the current environment and the financial performance of the semiconductor sector, something has to give. I have a feeling the stocks will give first. That's why I am keeping some powder dry even though the market is acting as if we are off to the races again.