Tech Mess
Analysts outline the problems in the critical high-tech sector.

By Edward B. Driscoll, Jr., a tech writer living in San Jose, Calif.
September 7, 2001, 8:00 a.m.

ear and loathing are alive and well in the tech sector, with tech stocks reeling and wired-in companies ailing from a lack of capital and backlogged inventory.

There is a little going right in the sector. Monday’s announcement of the purchase of Compaq by Hewlett-Packard sounded like the computer industry’s version of the 1968 Penn Central merger between the Pennsylvania and New York Central railroads. “You have two huge organizations that are underperforming and now you're going to complicate this by putting them together,” Craig Chodash of J. &. W. Seligman & Co. told Reuters.

By all accounts, technology is running a FILO (first in, last out) scenario — it was the leader of the boom of the 1990s and will be the follower in the anticipated general recovery due in 2002 (now apparently pushed out of this year's fourth quarter). This means that it may well be the third or fourth quarter of 2002 when the tech companies get back into the game. Which is a big problem. As Larry Kudlow points out in his argument for a cap-gains tax cut, if the tech sector does not rebound soon, the overall economy will continue to suffer.

Several tech analysts have outlined the problems for NRO Financial:

Richard Lane, Moody’s
The semiconductor sector is going to see its worst decline since 1985. This cycle is being significantly driven by a sudden stop of demand. And that evaporation emanates from a variety of sectors, but notably, the telecom and communications sectors, which were significant drivers to the general boom in the late 1990s. When you get rid of the telecom, the dot-com, and the other communication start-ups, the demand for semiconductors no longer exists.

In the past couple of months, people have been searching desperately for any new data point. Cisco said they might be able to execute upon lowered numbers, and people got all excited. Someone buys a few more chips in the wireless space, and there’s a boom among an array of semiconductor companies. Things have been so weak, that people have been looking for any sign of an upturn.

You’ve got to have an improvement in the macro environment, and not just the U.S. The U.S. environment softened first, and then Europe caught the cold. Latin America has its problems, Japan has its own woes, and the Asian Pacific areas are soft, broadly speaking. Even China has shown signs of softening. So improvement in the macro environment will be the key driver. Improvement is going to help demand, and demand is going to help absorb the excess inventories that remain in some element of the electronic supply-chain channel. You’ve got to get rid of the supply that currently exists. Some of that supply will be obsoleted, and then you’re going to start building new inventory to satisfy growing demand.
— Lane is Senior Vice President, Moody's, focusing on Investment Grade Technology Bonds

Zeus Kerravala, Yankee Group
Windows XP — now there’s an enigma. A lot of the product's new end users are not sure what to do with it. Many have just gotten through their Windows 2000 migrations, and boom, Microsoft’s hitting them with another operating system. I think you’ll see something similar with XP. It will have a quick impact on a lot of the workstations around the industry. It might help Microsoft, but I don’t really see how it will help the tech sector as a whole.

We've seen the meteoric rise in processing speeds and the decrease in the price of memory. Now, when you start going up to 800 MHz, a gigahertz, and 1.4 gigs, it doesn’t seem like there are any applications that need that kind of horsepower. Even most multimedia will run on an 800 MHz or gigahertz machine. So, the incremental processor speed increases aren’t having as big an impact as they did at one time. XP will certainly help some of its partners. Xdrive, the online storage provider, will apparently have an icon on the XP desktop. So companies like that will benefit. But I sincerely doubt that companies like Lucent and Cisco will see much upside. Dell and Hewlett-Packard feel that sales will be flat at best.

Businesses are saying, “Look, we just upgraded our machines for Y2K. And we probably did that with 800 MHz machines.” Most companies’ businesses can still operate on what they have.
— Kerravala is Director of E-Networks & Broadband Access for the Yankee Group

Howard Sitzer, Moody’s Investor Services
Our outlook on the high-technology sector with regard to corporate bond ratings and speculative grades is negative. We see rating-downgrades beginning to accelerate, and if not downgrades, a very high likelihood of outlooks being modified in a negative direction.

Many have prognosticated that the downturn would be of limited duration, or of somewhat longer duration, and so on, but it appears that we’re now into the third quarter of still further deceleration of activity. In terms of the rate of deceleration, that is slowing. But it’s not exactly clear that we’re bouncing along a bottom, as some others have categorized it.

In the third quarter, for many companies, revenues will be down another 5% to 20%. A lot of this will correlate with the macro economy. I think the corporate sector is currently adjusting to over-capacity levels, and more particularly, is determining at what point it’s appropriate to commit to additional information-technology investment.

Remarkably, computer sales are down in the U.S. for the first time ever. And I think that they’re more or less flat, worldwide. This looks to be the first year in the relatively short history of personal computers that personal computer sales will be down.

At the corporate level, there had been a trend of refresh cycles, where corporations overhaul all of the seats with new equipment on about a three-year basis. It appears that corporations are now deferring that overhaul towards four years. One of the issues allowing them that flexibility is that there just doesn’t appear to be any killer apps — new major applications that everybody has to have that are driving mass upgrades of software and attendant equipment installations.
— Sitzer is Vice President and Senior Analyst of High Technology Yield Bonds for Moody’s Investor Services

Adam Thierer, Cato Institute
Things don’t look good from a Washington perspective, particularly if you believe that what it is needed to jump-start the tech industry is some form of deregulation, or at least some form of regulatory certainty. The primary problem is not just related to the larger macro problems we see in the economy. Those certainly are contributing to it. But in many ways, the sector's lag is due to the fact that there is a disastrously uncertain regulatory climate that the tech carriers face, as they embark on a path of laying new networks and deploying new services or offering consumers new technologies.

If you know a little bit about telecom policy, it’s easy to understand why this is a problem. For years, we’ve known that telephone companies have been regulated one way, cable companies another, broadcasters yet another, and satellite and wireless still another way. And yet, all of these technologies are seeing some sort of convergence, and they’re all trying to offer consumers a relatively undifferentiated product: high-speed, broadband Internet access. But they’re all regulated under very different regimes.

Moreover, some of the telecom companies are regulated far more stringently than others. So there’s this question about how to achieve a level playing field in this area: Are we going to regulate or deregulate down? But we can’t even engage in that debate. Competing sides appear to be at an impasse. No one’s allowing anything to go anywhere.

So we’re stuck with an incredible amount of uncertainty in this industry. And of course, there’s probably no bigger curse in the investment community than not knowing what the market is going to look like in the next day, week, or month. If you have that sort of uncertainty, you are far less likely to invest — and in this case, investment means deployment, deployment of high-speed broadband. If companies are not deploying, they’re not even buying the stuff that’s going to be deployed. If carriers are not buying the underlying infrastructure equipment, telecommunications equipment suppliers are hurt. Uncertainty is the curse.
— Thierer is Director of Telecommunications Studies at Cato