Monday, July 02, 2007

Citi: Another round of 2H order cuts from INTC and TSCM

Citigroup has some fairly intelligent comments on the DRAM capex after a warning from Novellus Systems (NASDAQ:NVLS) last week:

- Firm's checks suggest NVLS's negative pre-announcement and new cost-cutting initiatives in 2H are primarily due to another round of 2H order cuts from INTC and, to a lesser extent, TSMC, owing to more equipment re-use at leading edge technology nodes. With CQ2 earnings, they expect the start of a process where consensus estimates come in ~20-30% over the next 6 mos and orders get progressively worse through 2H:07 (led by DRAM).

There appears to be a school of thought among bullish investors that DRAM capex per DRAM unit is at record lows and therefore DRAM capex is not at risk. Firstly, this is faulty analysis as capex relative to chip units always must be adjusted for wafer size (300mm cost ~30% more but drives more than 2x units). When adjusting for wafer size, DRAM capex is ~$0.22 per DRAM unit - up more than 2X since C2002, about equal to C1995 and eclipsed only by C1996.

The bottom line in DRAM, from Citi's view, remains the "funding gap" that has developed this year. As a reminder, C2007 is only the 3rd period in the past 15 years in which memory industry EBITDA will fall meaningfully short of capex. In prior funding gaps (C2001 and mid-1990's), capex was cut at least 30% the year after - in other words, history suggests memory capex (particularly DRAM) will be under significant pressure in C2008. Near term, they believe internal capex approval requirements in Korea (Samsung and Hynix) have been tightened dramatically in recent weeks. While few cuts have been made yet, this is moving in that direction and argues against the view that DRAM capex is OK.

Notablecalls: I continue to be bearish on the Semi Equipment space, especially the names with high exposure to DRAM capex.

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