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STREET WISE By Amey Stone February 10, 2000 All Charged Up over E-Appliance Chips A potentially rewarding way to play the boom in Net devices, from handheld computers to DSL, is through the chips that go into them It used to be enough to have a computer adorning your desk at work. Eventually, to feel really connected you also needed a PC in the den at home. Now, thanks to everyone's increasing reliance on the Web, you're naked without your PC plus an Internet connection between work and home -- and when you get there you want a Net link in nearly every room of the house. It will probably be a few years before you turn into a walking Net connection, but that's clearly on the horizon. The urge to log on from anywhere has fueled a surge in the stocks of companies that make so-called Internet appliances, such as 3Com (COMS), which will soon spin off its Palm Computing unit in a public offering, and Research in Motion (RIMM), which makes equipment for pagers and other mobile communications devices. But a less obvious -- and perhaps more lucrative -- way to play the coming boom in e-appliances is through companies that make the chips that go into them. NEW ARCHITECTURE. To highlight these opportunities, Merrill Lynch issued a Feb. 3 report called "Semiconductors for e-Appliances," which describes six new consumer markets for Internet devices. Don't just think handheld computer -- think digital camera, MP3 player, games, broadband access (set-top boxes, DSL, and cable modems), and home networking equipment. "We're a lot more excited about the e-appliance market, as well as the communications infrastructure markets, than we are the desktop PC market," says Joseph Osha, Merrill's lead semiconductor analyst. Merrill projects that sales of chips for these new appliances will double from $4.8 billion in 1999 to $9.6 billion by 2003. And it expects some categories to grow faster than that. From a 1999 base of only $34 million in chip sales for home networking equipment, Merrill predicts 87% annual growth, to $415 million in 2003. Sales of chips for MP3 players should grow 57% a year, to $338 million by 2003, it predicts. The largest submarket currently is for chips for broadband access devices, which Merrill expects to grow from a current $2 billion to $4 billion in 2003.   These stocks have already had steep runups in the past few months -- TI rose about 30% in less than two weeks   Merrill's report recommends seven companies that participate in e-appliance markets. (Many of these also make chips that go into other hot communications-related markets, such as Internet infrastructure and wireless phones.) Broadcom (BRCM) gets 50% of its revenue from set-top boxes and cable modems and is a leader in the emerging home networking market. SanDisk (SNDK), the only pure play Merrill mentions, supplies flash memory chips that go into digital cameras and MP3 players. LSI Logic (LSI) currently gets only 16% of revenues from e-appliances, but its chips also go into games, set-top boxes, and digital cameras. National Semiconductor (NSM) gets hardly any of its current revenues from e-appliances, but Merrill thinks its new Geode architecture will be big in the set-top box and handheld device markets. Merrill names Conexant ((CNXT) as a leading supplier of DSL chipsets with a strong position in home networking chips. And it cites Texas Instruments (TXN) as an "emerging player" in DSL and cable-modem chipsets. Linear Technologies (LLTC), another Merrill pick, provides low-power chips and gets about 10% of its revenues from e-appliances. Rather than single out a favorite, Osha recommends that investors buy a basket of these stocks as a way to smooth out some of the volatility in the sector. The big problem with playing all these stocks is that they have already enjoyed steep runups in the past few months as the semiconductor market has continued to strengthen. The stock of Texas Instruments, for example, has risen about 30% in less than two weeks on new contracts and analyst upgrades. Moreover, "just because a company will benefit from this boom doesn't mean we like them from the standpoint of buying their stock," says Manoj Nadkarni, an independent semiconductor analyst and president of ChipInvestor.com. He currently doesn't recommend any of the same stocks as Merrill, mostly because his criteria take valuations into account. "For us, it is too late to recommend Texas Instruments," he says. "The time would have been a year, year-and-a-half ago." (Merrill started coverage in June, 1999, with a "near-term accumulate" rating and upgraded it to "buy" in July, according to Briefing.com.)   "It's rare to see a stock cease to perform because it is expensive. If it continues to deliver, it goes from expensive to real expensive"   Still, Nadkarni is more of a stickler for traditional valuation measures than most chip analysts, who say that these stocks tend to trade more off of improving business fundamentals than price-to-earnings ratios. In the current market, as long as they deliver improving results and don't disappoint investors, the stocks can keep moving up, argues Arun Veerappan, an analyst with BancBoston Robertson Stephens. "It's rare to see a stock cease to perform because it is expensive," agrees Osha. "If it continues to deliver, it goes from expensive to real expensive." By way of example, he says that Broadcom, despite its high price, stands to have more upside because of the size of the markets it's in. Veerappan has been recommending Broadcom and National Semiconductor. Nadkarni, meanwhile, can still find some underfollowed companies that meet his valuation criteria. One he continues to recommend (and has a position in) is Keithley Instruments (KEI), which makes equipment used in testing chips that go into wireless devices. The stock, which Nadkarni says isn't followed by Wall Street analysts, has roughly doubled in the past six weeks and still has a current p-e of only 20. Lately, Nadkarni is studying companies that provide chipmakers with electronic design automation (EDA) software. He expects this subsector to benefit from the greater complexity of e-appliance chips. (Leading EDA companies include Cadence Design Systems (CDN), Synopsys (SNPS), and Mentor Graphics (MENT).) Semiconductor stocks, like tech as a whole, are particularly expensive after enjoying a remarkable hot streak over the past few months. But for investors who can handle the risk, new demand for chips used in e-appliances may well leave some chipmakers more room to run. Stone is an associate editor at Business Week Online _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					Amey Stone covers investing for Business Week Online WEB POINTERS To visit some of the sites mentioned in the story, click here: 3Com Research in Motion Broadcom SanDisk LSI Logic National Semiconductor Conexant Texas Instruments Linear Technologies ChipInvestor.com Robertson Stephens Keithley Instruments Cadence Design Synopsys Mentor Graphics Merrill Lynch