Morgan Stanley downgrades take shine off semiconductor industry

Investment house cuts industry rating, downgrade Intel and Nvidia

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Investment house Morgan Stanley unleashed a torrent of downgrades on the semiconductor industry today, taking some steam out of the idea that chip companies like Intel are leading an economic comeback.

Morgan Stanley cut its rating on the semiconductor industry from "attractive" to "cautious," while also downgrading the likes of Intel. Corp., Nvidia Corp. and Micron Technology Inc. Morgan Stanley analysts Mark Lipacis and Sanjay Devgan wrote in a note that rising inventories and concerns about PC component sales is driving them to be more cautious about the industry.

The downgrades and lack of enthusiasm about the chip industry came as a bit of a surprise to some who have been tracking signs that the semiconductor industry has been rising from the financial mire that's affected the economy at large.

Late last month, Intel President and CEO Paul Otellini told a Web 2.0 conference that the economy has already hit rock bottom and is now re-emerging from the recession, spurring many companies to take the lid off of IT budgets.

"We're likely to see PC unit volume this year above 2008, which you wouldn't have thought even three months ago," Otellini said less than two weeks ago. "The average desktop is five years old, a laptop is four years old. They have to be replaced. They're out of warranty. It's more expensive to keep the old ones than to buy new ones. And CIOs are buying that argument."

Otellini had good reason to be optimistic.

Just the week before, Intel reported strong third-quarter earnings that beat analyst expectations. The company pointed to third-quarter revenue of $9.39 billion for the period ending Sept. 26, beating the estimates of $9.04 billion. Revenue was even up by $1.4 billion compared to the previous quarter.

As of today, there's more pessimism in the air.

"I think it shows a concern that the industry may have overbuilt for the fourth quarter and that economic conditions simply aren't where they need to be to consume the existing inventory," said Rob Enderle, an analyst with The Enderle Group. "Realize that we are getting really mixed signals at the moment with regard to the market recovery and that is making the financial community very nervous and conservative at the moment."

Enderle, however, said this doesn't seem to be a direct reflection of what analysts think of companies like Intel and Nvidia.

"I think this is more a reflection on the global economy and continuing concerns that IT spending doesn't appear to be increasing yet," he added. "Most of us are starting to look at 2011 as the year IT spending may come back as a result. Certainly, it isn't a good sign. But it reflects the reality of the economic conditions and not a unique weakness in the chip segment. Until IT spending comes back, or until a big technology change, like 4G, stirs up this market, we'll likely continue to see firms like Morgan Stanly take a conservative position."

Dan Olds, an analyst with The Gabriel Consulting Group, said he thinks Morgan Stanley may be a bit off base with its downgrading.

"As a sector, I don't see semiconductors as particularly weak right now," said Olds. "Of course, they're feeling the effects of the economy as a whole. But the medium- and long-range outlook for the industry is bright. In some ways, the recession is actually helping semiconductor sales as companies use advanced technology to cut costs by automating operations. The short-term weakness is, I believe, mainly due to both consumers and businesses preserving cash, though they're postponing purchases rather than canceling plans."

He added that technology remains near the top of most business and even consumer wish lists, so when the economic tide does turn, tech companies will feel early benefits as executives and individuals again open their wallets.

"As for the Intel downgrade, it's hard to fathom in some ways. Intel executives are usually fairly conservative in their guidance and they were reasonably upbeat in their last release," said Olds. "Looks like all of Morgan Stanley got up on the pessimistic side of the bed this morning."

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