Tuesday, October 23, 2007

Tech Wreck

We've had ongoing weakness in profits for much of the technology sector so far this reporting season. But the sound of all the earnings misses has been drowned out by a handful of rapidly-growing companies with high multiples and even higher expectations. Jim Cramer of CNBC infamy has dubbed them the Four Horsemen. GOOG, RIMM and AAPL produced big numbers to feed the Nasdaq frenzy but the 4th horseman stumbled badly after the close today.

AMZN delivered strong revenue growth and beat profit expectations slightly - which was fine. Then they dropped a bombshell with their guidance.


Operating income is expected to be between $221 million and $291 million, or grow between 12% and 48% compared with fourth quarter 2006.
First problem is the range is wide enough to drive a truck through. That tells you they have no real idea what is going to happen - rarely a good sign. Second problem is that expected EPS growth for 4Q is 100% year over year. At the top of their guidance, they only fall short by half. At the bottom of the range, their profit growth will be one-eighth of expectations. That kind of miss is really bad and potentially disastrous for a high-flyer like AMZN.

What is important here is that the miss by Amazon will force people to look at what is actually happenning to earnings in technology and not just a few hyped up names. When they do look, they will see a rather ugly picture behind the hype. Almost every major technology company to report so far has had serious problems - either revenue shortfalls or forward-looking weakness as reflected in guidance. Many of them are big, even dominant players in their sector. Here's a partial list:

Chipmakers
Texas Instruments - analog semis and digital signal processors
Broadcom - WiFi and other communications chips
Altera - PLDs (key components in telecom and networking gear)
Linear Tech - analog and mixed-signal semis
Microchip - microcontrollers for consumer and industrial applications

Systems
Ericsson - cellphones and cellular network gear
Alcatel/Lucent - communications equipment
IBM - weak hardware demand

Many of the semiconductor companies are telling us that 4th quarter revenues will be weaker than last quarter. That is the opposite of the normal seasonal pattern, suggesting a significant weakening of underlying demand. These chipmakers' customers are a very broad cross-section of the global technology sector and encompass tech's A-list, so the weakness is broad-based as well.

For months, the question has been "if a tech company falls in the forest, will it make a sound?" The answer has been a resounding NO. Now we're about to find out what happens when one falls in the front yard and crushes the house.