Larry will be back from a short vacation tomorrow. So this morning, I’m jumping in to alert you to continuing dangers in the tech world . along with two bright spots you should check out for 2006.
I own two software companies myself. So I’m a big believer in tech. But that doesn’t mean I’m a permanent tech cheerleader.
In fact, all year long, I’ve been feeding readers a steady stream of alerts about a tech slowdown .
Semiconductors
Still in Trouble
In January, I warned about semiconductors. Sales had fallen in all regions of the globe except Europe, a prelude to more trouble ahead. At best, the industry was projecting flat sales for the year. So I wrote:
“`Flat’ just won’t cut it when stocks are selling for outrageous growth multiples. How outrageous? Intel (19 times earnings), Micron (23 times), Applied Materials (20 times), Texas Instruments (21 times), KLA Tencor (23 times), and ST Microelectronics (26 times) are examples.”
Update: Sales have been better than I expected, but still disappointing. According to Gartner Research, global semiconductor sales will be $235 billion in 2005 – a paltry 6.9% increase over 2004.
Given the wild popularity of iPods, Blackberries, and personal digital assistants, that’s pretty darn unimpressive.
Meanwhile, I think most semiconductor stocks are still way overvalued. So expect more disappointment in 2006.
PC Industry
Sinking Further
In February, I began warning about Dell and the entire PC industry.
At the time, Dell’s bread-and-butter desktop PC business was already shrinking, accounting for 51% of Dell’s total sales in 2004, down from 52% in 2003.
Meanwhile, whatever growth Dell was getting was not from the computer business. Printer shipments, for example, had increased by 111% at the time. Receivables and inventory were also growing, more signs of disappointing sales.
I concluded:
“The PC business is maturing into a slow-growth industry with only a fraction of the upside it had in the 1990s. The PC business is no more whiz-bang than the refrigerator or the lawn mower business . Yet, the bulls continue to value Dell today like the great growth machine that it was in the 1990s.”
Update: Dell’s stock has taken a big beating. Through December 27, it’s down 26.6%, trading in the $30 range. And I wouldn’t be surprised to see it fall below $20 as it continues to report falling profit margins and slowing growth in earnings per share.
For 2006, IDC predicts a 10.6% increase in unit sales industry-wide. But even if they’re right, there are two problems with that kind of growth:
First, it represents a significant drop from the 15.8% growth of 2005.
Second, once you factor in the steady decline in the average selling price of computers, the outlook gets even gloomier.
Trouble in Most of
Wireless Industry
I say “most” because one of the bright spots I’m going to tell you about is in a small sub-sector of the wireless industry. But first, the bad news:
I started warning you about the industry in March when two of the world’s largest makers of chips for cellular phones – Texas Instruments and Qualcomm – had effectively told Wall Street that their sales targets were way off.
You didn’t have to be a genius to figure out that the wireless business was not nearly as red-hot as Wall Street thought it was.
It’s an old story that has been repeated many times in history: What starts out as super-duper technology ends up being a low-margin, intensely competitive, commoditized business.
Radios used to be an amazing marvel. So were microwave ovens, televisions, calculators, phonographs, and my favorite – the remote control. This year, the same thing happened to the cell phone business. My words in March:
“Of course, this has important implications for investors. Of course, the cell phone makers (Nokia, Ericsson, Motorola) and wireless vendors (Verizon, Cingular, Sprint) are obvious companies to avoid.
“However, that is just the tip of the iceberg. If you took a cell phone, smashed it on the ground, and figured out the component vendors, you’d get another list of companies to avoid, such as Triquint, Powerwave, RF Micro Devices, REMEC, and Openwave Systems.”
Update: Two months later, in May, the Wall Street Journal finally picked up on the trend with a headline article entitled “Slower Growth Hits Cellphone Services Overseas.”
And since then, the stocks of most major wireless providers have done poorly, while chipmakers were a mixed bag of big winners and big losers.
Looking ahead to 2006, two areas I would avoid like the plague are the cellular providers (Verizon, Sprint, etc.) and companies that make the phones (Nokia, Ericcson, Motorola, etc.).
I say that because two-thirds of Americans already have cell phones, and the ones that don’t probably can’t afford one. That means some intense, cut-throat competition to steal each other’s customers.
Sure, there will be some unique innovators that come up with faster, better, or cooler pieces of software or silicon. But blindly buying the oldest names in the business could lead to disaster.
DRAM Chips Sink
On June 24, I warned that DRAM memory chips had fallen like a rock – 30% in just 90 days, according to Micron Technology.
Micron Technology reported a $127 million (20 cents per share) loss for the quarter ending June 2 – the largest quarterly loss in two years. Quite a miss for Wall Street, which was anticipating a 2-cent profit!
What was going on? Simple: Tennis shoes and TVs weren’t the only products that could be produced cheaper in Asia. Two South Korean Companies – Samsung Electronics ($7.5 billion of sales) and Hynix Semiconductor ($4.3 billion) were – and are – lower cost producers.
Meanwhile, Micron’s inventory of unsold chips was jumping – from $752 million to $826.7 million in just 90 days.
My conclusion in June:
“That surge in inventory is going to translate into more profit shortfalls down the road. Even though Micron has dropped by 90% from its split-adjusted high of $100, I believe it has a long, long ways yet to fall and I suggest you stay far, far away.”
Update: Since then, Micron’s shares have rallied along with the rest of the market, but I think that is about to change in a big way.
Indeed, just last week, Micron reported a 60% plunge in its quarterly profits because of a 15% drop in the price of DRAM chips. And that decline is just the tip of the iceberg.
Heck, the Justice Department recently fined Samsung $300 million for its role in a price fixing scheme that also involved Hynix Semiconductor, Infineon and Micron. So imagine the price declines that are possible if they stop price-fixing!
Why Cisco’s a Dog
On August 10, I warned you about Cisco. The company hit its Q2 numbers square on the head. But everything else looking forward didn’t sound nearly as good as Wall Street had expected.
Cisco itself expected sales in the following 12 months would grow by 10% to 12%, compared to at least 12% sales growth that Wall Street was hoping for. My conclusion in August:
“The world just isn’t stampeding to buy Cisco high-priced routers and switches like they used to.
“Nobody should pay 17 times earnings for a company that is only growing by low double-digits.
“Even the attention-deficit-disorder crowd on Wall Street is starting to get the picture. Standard & Poor’s downgraded Cisco and warned that it didn’t see any `material catalysts on the horizon.’
“I couldn’t agree more. Cisco is a dog and well on it’s way to seeing its stock price fall drop into single-digits in the not-too-distant future.”
Update: On August 10, Cisco’s shares were sitting at $18.25. Now they’re in the low $17 area, and I think the slide is about to accelerate.
I say that because right before Christmas, Solectron reported that its Q3 profits fell by 50% and that its sales fall by 9%. Cisco, by the way, is Solectron’s largest single customer.
Best Buy Disappoints
On September 13, I told you how retail star Best Buy reported worse-than-expected quarterly results and told Wall Street to tone down its euphoric expectations.
Since 36% of Best Buy’s sales were home office products like computers, printers and telephones . and since same-store sales declined 0.7%, it was easy to connect this dot to everybody in the PC food chain, such as Dell and Intel.
My conclusion in September:
“This is a pretty serious retail warning. We’re not talking about some small, trendy retailer – we’re talking about one of the brightest and biggest stars in the retail world. When Best Buy coughs up a hairball, you better pay attention.”
Update: In December, Best Buy again reported worse-than-expected quarterly results with only 28 cents of earnings for the quarter ending October 30. Wall Street was expecting 30 cents.
Best Buy also warned that the current quarter doesn’t look so hot either.
This quarter includes not only the December holiday shopping spree, but also the cashing-in of gift cards in January. If Best Buy can’t hit its sales and profit target during this sweet spot of the retail year, the rest of the year is going to stink even worse.
Chickens Coming
Home to Roost
The warnings and events I’ve highlighted this morning leave me little doubt that:
- The tech fundamentals have been deteriorating all year long.
- They’re far-reaching, likely to drag down – or even gut – the profits of many of Wall Street’s favorite tech companies.
- It’s going to be awfully tough for the Nasdaq to continue rising in that environment. Double-digit declines are far more likely.
- Starting next year, you’re going to hear a parade of tech companies reporting both disappointing sales and disappointing profits.
Strangely, the Wall Street crowd is as optimistic as ever. In fact, a Business Week poll of 76 Wall Street experts expects the Nasdaq to rise by 7.6% in 2006. To me, that kind of disconnect between hope and reality spells trouble for most tech stocks.
So much for the big picture. Now for a couple of the bright spots .
Bright Spot #1
Near Field Communication
Likely to Take Off in 2006 
I’m proud to tell you that my oldest son, Ryan, is an engineering student at Texas A&M.
One habit that causes us grief, however, is his tendency to lose things like his wallet, car keys, or checkbook.
But he has never, ever lost his cell phone. For most young adults, a cell phone is their social lifeline, virtually glued to their hands.
The administrators at the Kanagawa Institute of Technology in Japan have come to the same conclusion: Students rarely lose their cell phones. That is why starting next semester, they will store student IDs on cell phones.
By simply holding their cell phone close to a registration terminal, students will be able to electronically register for classes.
They will also be able to open locked campus doors . buy food at the school cafeteria, bookstore, and vending machines . even get discounts at local movie theaters, restaurants, and shops.
That may sound ultra-futuristic, but it really isn’t. The Japanese college is using a well-established technology called “Near Field Communication” (NFC).
Not only is Near Field Communication an amazing technology, I believe it will be one of the biggest investment opportunities of the decade.
What, precisely, is it? NFC is simply the process of using encrypted radio frequency over very short ranges to connect wireless devices with other electronic devices, such as PCs, cell phones, and consumer electronics.
Bright Spot #2
AMD Will Gain a
New Customer: Dell
I’ve been consistently telling readers how bright the future looks for Advanced Micro Devices . and how dismal Intel’s prospects are.
Part of my ongoing rant about Intel – in addition to the shrinking PC business, falling prices, excess capacity, and shrinking margins – has been the competitive threat from Advanced Micro Devices.
In simple terms, AMD has built a better mousetrap than Intel. Its new Athlon 64-bit chip is faster, better, and cheaper than any of Intel’s offerings. That is why over 80% of the computers sold in retail stores use AMD chips – not Intel chips.
And right now, the only significant (and very major) computer maker that hasn’t embraced AMD chips is Dell.
Because the price of PCs keeps falling and pulling profit margins down with it, my view is that it’s only a matter of time before Dell will start using AMD chips.
And the day that happens is a day that will drive AMD’s shares skyward, while crushing Intel’s.
Forget about price for a moment. Most studies have shown that AMD chips are (a) faster, (b) use less power, and (c) give off less heat than Intel chips. Even if Intel chips were just as cheap – which they’re not – most experts would agree that AMD chips are superior.
Example: AMD beat Intel to the punch with its new generation of 64-bit processors, which processes larger chunks of data faster than the previous generation of 32-bit processors.
Proof of the pudding: In September, 52% of all desktop computers sold in the U.S. had AMD processor chips. Intel’s market share was only 46%!
The last major Intel holdout is Dell. But I doubt that will last much longer. This year, AMD added a former Dell executive, Mort Topfer to its Board of Directors. And I can assure you, AMD didn’t ask Topfer to join its board for his good looks. AMD pulled Topfer on board because AMD expects him to call his old buddy Michael Dell and persuade him to start using AMD chips in Dell computers.
My Recommendations
First, if you haven’t done so already, lighten up on tech companies in a big way, especially in the weak sectors I’ve been warning you about.
Second, stash the cash. With all the Fed’s rate hikes, you can now get a not-so-shabby yield on virtually riskless investments like Treasury bills and Treasury-Only Money Funds.
Third, if you feel you must hold on to vulnerable tech stocks for some reason, then at least hedge your tech stock portfolio with instruments that are designed to go up when the Nasdaq goes down. For example: the Rydex Arktos Fund.
Fourth, stay tuned. The bright spots I’ve told you about in recent issues are going to open up some great profit opportunities in 2006.
Best wishes,
Tony Sagami
About MONEY AND MARKETS
MONEY AND MARKETS (MAM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Larry Edelson, Tony Sagami and other contributors. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MAM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MAM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Contributors include Marie Albin, John Burke, Beth Cain, Christine Johnston, Amber Dakar, Michael Larson, Monica Lewman-Garcia, Julie Trudeau and others.
© 2005 by Weiss Research, Inc. All rights reserved.
15430 Endeavour Drive, Jupiter, FL 33478
