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A Chill In The Valley


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A CHILL IN THE VALLEY

America's high-tech mecca feels twinges of slower growth

During a recent discussion of the world economy at a gathering of high-tech insiders in San Jose, Silicon Valley entrepreneur Harry Saal asked a crowd of 500 of his peers a simple question: If the Valley were a stock, would they buy, sell, or hold? What with the meltdown in emerging markets, the stock market tumult, and talk of a U.S. recession--not to mention cutbacks from Valley powerhouses like Hewlett-Packard Co. and Applied Materials Inc.--you might expect some skittishness. Not so. "Only one or two hands went up in favor of sell," says Saal.

Had these folks had too much chardonnay? Not likely. By almost any measure, Silicon Valley's economy is still on track to remain the envy of the world. Almost $13 billion in venture funds will flow into the area this year, on a par with 1997's record level. Unemployment was just 3.4% in August, compared with 4.5% nationwide. Commercial vacancy rates for the most popular areas are less than 5%, roughly half the rate in other major markets. And the mood by and large remains buoyant. At Ferrari of Los Gatos, $250,000-plus models are still selling--and the buyers include Joseph R. Kraus, the 27-year-old co-founder of Excite Inc., and Theodore W. Waitt, CEO of Gateway Inc. "I don't have a sense of looking over the precipice," says HP economist Richard C. O'Brien.

That doesn't mean Silicon Valley isn't in for a reality check. Companies including Seagate Technology, HP, chipmaker LSI Logic, and semiconductor-equipment maker Applied Materials have already laid off more than 30,000 workers. Big players such as Intel Corp. and HP that have felt the crunch from Asia are bracing for more volatile times. Assuming no more global disasters, HP's O'Brien sees worldwide capital spending growth falling to 5%, from 12% a year ago. PCs are still selling well, but ever lower prices are crimping profits.

And while venture capital is still flowing, public stock offerings--a key form of Valley wealth creation--are off. Researcher VentureOne Corp. says there have been only 68 IPOs so far this year, vs. 97 in the same period of 1997. VentureOne says depressed stock prices have also slowed mergers--from 138 in 1997 to just 55 so far this year.

That has some venture capitalists changing tactics. Rather than lining up more new startups, many are sticking to latter-stage financing or even investing in public companies. "People realize the party is over, and it's having a sobering effect," says John A. Hawkins, managing general partner at Generation Partners, a venture-capital firm. In fact, valuations for startups have come down by as much as 35% in recent weeks, says Hawkins. "Like any boom, this one created excesses," says Daniel H. Case III, chairman and CEO of Hambrecht & Quist.1985 REDUX? Even the Bay Area's sizzling real estate market is cooling. Until recently, you could sell a starter home in a day for as much as $100,000 over the asking price. But now, the San Jose Real Estate Board figures housing prices will rise just 5% this year, down from 11% in 1997. On the commercial side, developer John Mozart expects prices for developed properties to drop 10% to 20%, and some land prices to plummet as much as 40%. "There are just not a lot of buyers for big properties," he says. "I can count them on one hand."

How bad will it get? Few analysts think the Valley is in for the kind of pain it suffered in 1985, when the PC industry contracted. Microsoft, Sun, and Intel have all reported surprisingly strong quarterly results. And there's no sign of letup in Internet development. There's even hope for the battered semiconductor industry. While revenues should fall 15.7% this year, "the general consensus is that we've hit bottom," says G. Dan Hutcheson, president of market researcher VLSI Research Inc. "Now that we've gotten through the worst of the downtime, now's the time to be aggressive," says James C. Morgan, CEO of Applied Materials, the top manufacturer of chipmaking equipment.

Still, if the world financial market does worsen, look for more tumult in the Valley. Already, thanks to underwater options, headhunters report that it's easier to lure execs from their longtime employers. Compensation consultant Matthew Ward of WestWard Pay Strategies says many companies are ready to reprice their options in short order if the stock market plunges again. Advanced Micro Devices Inc. and VLSI Technology Inc. have already done so.

Many Silicon Valley veterans say they actually welcome a breather. "As a resident, there's a part of me that's happy to see the frenetic stuff calming down," says Sun Microsystems Inc. Chief Financial Officer Michael E. Lehman, who has had three unwanted visits from real estate agents offering to sell his house in the last year. If the Valley outlook stays the same, his doorbell should get awfully quiet.By Peter Burrows, with Linda Himelstein, in San Mateo, Calif., Otis Port in New York, and bureau reportsReturn to top


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