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Posted 4/25/2005
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Technology: Use the gadgets, avoid the stocks
When you dig into the earnings of many tech companies, including IBM, TI and Intel, you find things that suggest business isn't as rosy as the CEOs say.
By Bill Fleckenstein
This week's column begins with a vignette of what passes for securities "analysis" these days. Let's rewind to April 18, when Texas Instruments (TXN, news, msgs) held its first-quarter conference call. A participating dead fish did his species proud when he piped in: "Speaking for the bullish analysts, thanks for throwing us a life preserver."
Now I thought analysts were supposed to be analysts and not necessarily desire to be bullish. Thanking Texas Instrument's management for throwing the dead-fish community a life preserver (by not announcing bad news) hardly strikes me as analytical sleuthing.
Earnings yeast for a chip cake
That endeavor is the province of live fish, with the big tuna being my friend Fred Hickey, the editor of the High-Tech Strategist. He pointed out that Texas Instruments' beat-the-number results were due in part to a rounding error achieved by a share buyback worth $1.3 billion -- which allowed the company's earnings calculations to be 23.7 cents (ergo, the reported number of 24 cents), instead of 23.4 cents.
Texas Instruments' sales are down year-over-year, and their inventories are up year-over-year. The company has taken a damn-the-torpedoes-full-speed-ahead tack. It continues to increase fab loadings (i.e., planned production at its fabrication facilities) and claim that more inventory is needed to run its business going forward. Of course, building that extra inventory has helped margins and helped TI beat its earnings targets up to this point.
But given that end demand appears to be slowing (and is likely to slow even further), this is a risky gambit. Should end demand not pick up dramatically (which is my expectation), the company is going to find itself in a very difficult position.
No more rabbits in the Big Blue hat
If end demand were really firm in technology, it's hard to see how IBM (IBM, news, msgs) could have had the disappointing quarter it reported recently. And I have previously cited other examples, as well. The company's business was weak across all product areas and all geographies. (In an amazing display of stock-price weakness, April 20 marked the 14th straight day of declines in IBM's shares.)
Related news and commentary on MSN Money
Of course, that's where the pompoms come in -- to pinch-hit for actual good news. To wit, on its recent conference call, IBM introduced a new metric into the dead-fish lexicon. By my reckoning it ranks up there with folks counting eyeballs during the Internet heyday: Big Blue talked about deals in its pipeline, i.e., "Our phone rang, and we got some requests for proposals." Bottom line: I think folks can expect more bad news out of IBM this year, as the onion gets peeled back and we see what's inside.
A lame effort from Linear Tech
While in the less-than-meets-the-eye department, I'll note that Linear Technology's (LLTC, news, msgs) 39 cents in fourth-quarter earnings would in fact have shrunk to 30 cents had it excluded some $40 million in revenue via, as the company said in its fourth-quarter press release, "terms of a settlement and license agreement with another company."
That exclusion let Linear pretend its income strength was part of continuing operations -- and pretend that it didn't miss the number, which it did. For once, however, that gambit didn't work, as Linear Tech ended the session on April 20 down about 6.6%.
Probing Intel's innards
Contrast that bit of looking under the hood with the usual hoopla around Intel (INTC, news, msgs). Though it beat the number, the company said it expects sales to be down about 5.6% sequentially, slightly below what had previously been anticipated. That Intel stretched to make this quarter can be seen by the fact that, even though its revenues were down 2% sequentially, accounts receivable were up 7.5% and inventories were up another 7%.
Meanwhile, though Intel announced that its gross margins are expected to be lower this quarter, it threw the bulls a bone -- saying it thinks margins will be back up by the end of the year, and it expects to increase capital expenditures even further.
On the conference call, Intel was forced to admit that its big improvement in gross margins in the past quarter, which helped it "beat the number," could be explained as follows: "The key drivers of this sequential progress were lower microprocessor-unit costs, sales of inventory that had previously been written down, and the absence of a special year-end employee bonus." The italics are mine.
Of course, Intel didn't bother to tell us how much of this written-down inventory contributed to the improvement in earnings, because in my opinion, Intel's goal is obfuscation, not illumination.
That attempt is transparent in the eyes of a knowledgeable friend, who after doing some quick math pointed out the following: Microprocessor units for Advanced Micro Devices (AMD, news, msgs) and Intel were only down about 1% to 2% sequentially in the first quarter. Personal computer units, meanwhile, were down 7% sequentially. And the same occurred in the fourth quarter, when the two collectively shipped units well ahead of PC demand.
Overbuilding widgets invites woe
That's two quarters in a row of this, and Intel is again building inventory and upping capital-expenditure spending. It doesn't take a genius to see that, without a blistering improvement in end demand, Intel is an accident waiting to happen, and that's without taking into account the competitive threat posed by AMD.
I will note that the big improvement in Intel's business year-over-year came from the Asia-Pacific region, as both the U.S. and Europe were down. Of course, that jibes with what we can see with our own eyes. Whether there's true end demand in Asia-Pacific that is helping Intel or whether, somehow, some customers have been so stuffed with chips they're refusing to buy more, (as Intel's balance sheet might imply), we can't know yet. But we will, in the fullness of time.
Dance of the bulls and the corporate shills
Lastly, on the subject of things unknowable, I find it amazing that corporate chieftains in technology can declare what the future will be, and that people, especially the dead-fish community, tend to believe it. If either I, as a director of Pan American Silver (PAAS, news, msgs), or that mining company's CEO, stood up and said we knew precisely where the price of silver was going to be next quarter, people would laugh at us.
Yet, when captains of technology say this is the bottom or next month is the bottom, even when they operate at the back of the food chain, people assume that they are clairvoyant. That's just another data point indicating how infatuated the world happens to be, from an investment standpoint, with all things related to technology.
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckensteincapital.com site. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of MSN Money. At the time of publication, Bill Fleckenstein was long Pan American Silver, long Advanced Micro Devices, short Texas Instruments, short Intel and long Intel puts.
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