Chip companies may face a drawn-out recovery

Despite upbeat pronouncements by Intel about its resurgent sales and evidence the economy finally is growing, the prospects for other chip companies and their thousands of Silicon Valley employees remain unsettlingly murky.

Those optimistic about the industry's immediate future cite a big jump in chip shipments in recent months and the potential for a bump in holiday sales of tech gadgets — and the chips inside them.

They also point to the launch of Windows 7, which could spark purchases of personal computers outfitted with the latest microprocessors. That could especially benefit Intel and Nvidia, both of Santa Clara, Calif., and Advanced Micro Devices (AMD) of Sunnyvale, Calif., according to a Deutsche Bank study.

But others fear the sales upsurge in chips may be a mirage based on short-term changes in inventories maintained by computer makers, with a full-fledged, consumer-fueled recovery not likely to happen until after 2011 or even past 2013 for some chip sectors.

If the pessimists are right, it could mean a painfully drawn-out recovery for an industry that generates tens of billions of dollars in revenue and whose fortunes are heavily intertwined with Santa Clara County's tech-dependent economy.

"The question is demand," said Michael Palma, a semiconductor specialist at market-research firm IDC. "When does it return? Everyone is trying to figure out exactly how consumer spending is going to come back."

Specialty chip-makers — ranging from Xilinx, Cypress Semiconductor, and LSI to Maxim Integrated Products, National Semiconductor and Altera — employ a good chunk of the local workforce. It's hard to get a precise count of how many people are on their payrolls because many of their jobs are lumped in with those at other types of businesses.

But San Jose-area chip companies accounted for 37,475 manufacturing jobs as of September, according to California officials. And that's down 5,615 from the like period a year ago, largely due to the recession. So if the industry bounces back, some of those jobs might return, too.

Much of the uncertainty about the sector stems from the way computer makers and others rapidly scaled back their semiconductor inventories when the economy started going south — a lesson learned from the 2001 dot-com crash, when a glut of stockpiled chips prolonged the industry's financial woes, analysts say.

But the quick action this time also has made it hard to tell if the recent increase in chip shipments reflects real consumer demand or merely that businesses went too far in reducing their inventories and now need to restock in case consumer purchases actually do pick up, according to several industry experts.

Bill McClean, president of IC Insights, a semiconductor research firm in Scottsdale, Ariz., is among those who believe the recession has panicked companies into using up their existing semiconductor supplies and buying few, if any, replacements. That prompted what he called a record plunge in new chip shipments during the fourth quarter of 2008 and first quarter of this year.

But since then, McClean said he's seen a huge surge in chip sales, which he takes as evidence of booming consumer demand for electronic products.

"It's absolutely phenomenal," he said of the rebound.

Where's the bottom?

But in a recent report, research firm IDC forecast that sales of chips used in video games, portable media players and other devices "are not likely to return to pre-recession levels until after 2013."

Much of the optimism centering on the chip industry was triggered in April when Intel CEO Paul Otellini said the PC sales slump had "bottomed out." Since then, he and other Intel managers have sounded increasingly upbeat about their business prospects.

And in a recent analysis, the San Jose-based Semiconductor Industry Association noted that chips sales have been spurred by demand for netbooks and by "various incentive programs for energy-efficient products, ranging from automobiles to home appliances."

An additional boost for the industry is widely expected to come from Windows 7, the new computer operating system. If that results in more personal computers being sold, it would mean more sales of the chips built into those computers.

The holidays should generate even more purchases of gadgets loaded with chips, FBR Capital Markets analyst Craig Berger wrote his clients recently.

"We have little faith that consumers can restrain themselves for a second consecutive year," he concluded, noting that "Christmas was largely canceled last year."