Why the Chipmakers Are Down for '07

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businessweek.com/ticker/' rel='ticker'>HPQ) and Dell (DELL), analyst Chris Danely of JPMorgan observed that Intel's share of this business is shrinking. "We estimate Intel's average share of the PCs fell from 81% in August to 76% in December, driven by share loss at Dell. Dell notebooks with AMD processors rose from 0% in August to 11% in December, and Dell desktops using AMD processors rose from 0% in August to 21% in December," Danely wrote. The situation with server computers is similar, he reported.

Woes in Wireless

True, Intel has the performance edge of the moment, and that should start to make a difference in 2007, Danely said. "We expect Intel's share to stabilize in the first half of 2007…but we believe PC companies will continue to use AMD for pricing leverage," he added. That will pressure profit margins at both companies.

Meanwhile, the wireless business looks far bleaker. Texas Instruments (TXN), the market leader in chips used in mobile phones, slashed its profit and revenue forecast for the current quarter, and suggested that sales could slow further in the new year. Merrill Lynch analyst Joe Osha said one big part of the problem was an overhang of unsold chip inventory. "TI put the brakes on production as early as late in the third quarter," he wrote in a research note issued Dec. 12. "We do not believe the internal inventory will come down until the March quarter of 2007."

Warnings at chipmakers Xilinx (XLNX) and Altera (ALTR) are painting a gloomy picture for the first half of the year. Altera said a soft market for wireless infrastructure would force it to forecast a bigger drop in sales—5% to 7% for the quarter, worse than the 2% to 5% drop it had previously expected. Customers are buying fewer programmable gate array chips, which are employed in wireless-networking equipment such as that bought by wireless carriers.

Olympian Gold?

Xilinx is being hit by the same market conditions; it warned on Dec. 7 that sales were also suffering. Danely and Osha both issued dueling downgrades on the stock. Osha thinks the picture is worse at Xilinx than at Altera. "The reasoning is simple—Xilinx is still sitting on 63% of the floating point gate array market as compared to 37% for Altera, and a significant portion of the revenue is comprised of business won when Altera was crippled competitively," he wrote. Danely noted that inventory in the supply chain for communications-gear companies stood at 89 days in the third quarter, well above the usual level of 85 days. That bloated inventory is slowing orders at both Xilinx and Altera, he said.

So while it's clear that for chipmakers having a happy new year depends on your end market, what makes 2008 look so good? All the butterflies, kinks, and bugs associated with the adoption of Microsoft's Windows Vista should be worked out, and companies and consumers alike may be eager to revamp aging fleets of PCs. And those PCs will need more memory than ever before to keep up with the new operating system, says Matas of IC Insights. "It takes at bare minimum 750 megabytes of memory to run Vista, and it's much better at one gigabyte," Matas says. "That's going to push the average amount of memory per PC up."

Also, 2008 is both an election year and an Olympic year, with all that implies. "We've often seen good boom years for chip demand in Presidential election years. And we think China will want to show off how technically advanced a place it is during the Olympics in Beijing, so we'll certainly see a lot of action resulting from that."

Hesseldahl is a reporter for BusinessWeek.com.