Chip Stocks Face Overwhelming Abundance

by: Dana Blankenhorn

One of the key advantages of cloud computing is that it makes more efficient use of hardware. Thus, you need less hardware over time. And when hardware is sitting in a server room, under active management, it's unlikely to be replaced until it either breaks or something much, much better comes along.

Similarly, one of the key advantages of devices over PCs is there are no moving parts. Look at your iPad. There is no aluminum hardware drive spinning, no DVD drive running under a laser reading head. It is not just rugged, but it's very, very hard to break.

IHS iSuppli says the market is now realizing the savings from all this, in the form of a declining chip market. The market research and supply chain experts now expect worldwide chip shipments will have declined this year, for the first time, from $310 billion to $303 billion.

This is the third time in a year the company has taken down its forecast, each time in a negative direction. And a lot of people are going to cry "oh noes" over this fact, downgrading shares in such big chip companies as Intel (NASDAQ:INTC), Qualcomm (NASDAQ:QCOM), Nvidia (NASDAQ:NVDA), Broadcom (BRCM) and Texas Instruments (NYSE:TXN).

But it would be wrong to assume this means a declining tech market. What money doesn't flow into hardware is going to flow into software, into services, into finding ways to make use of this unprecedented computing abundance.

As in all such estimates, of course, the damage won't be spread uniformly.

Intel is being hurt by the fall in PC sales, down 7.8%, reducing demand for the x86 line of microprocessors, but those companies supplying the booming trade in tablets and phones, like Qualcomm and Broadcom, are going to see big improvements.

I would add this warning, however. Eventually, even these markets saturate. Already there are people running their third or fourth smartphones, their second or third tablets. The old units aren't all shredded, they are passed down into other markets. This will create an upgrade path for later buyers, but since these systems are fairly rugged by design they are going to last longer than PCs ever did. Improvements in operating systems and new features can generate just so many upgrades at the high end - eventually competition compresses margins and the market settles down. I expect this will start happening either late next year or early in 2014.

There is something to be said for these companies trying to find new markets. Texas Instruments, which mostly failed in the mobile market, is looking for profits in embedded markets, in chips that are parts of other products, like cars.

The reality of chip abundance is also behind the recent purchases by hardware companies like IBM (NYSE:IBM), Oracle (NYSE:ORCL), Hewlett-Packard (NYSE:HPQ) and Dell (NASDAQ:DELL) of cloud and enterprise software companies. This is not unexpected news, in other words - plans have been in place to deal with this new normal for some time.

The best news is that, as revenues move away from chips and hardware, into software and services, they move naturally from areas dominated by Asian companies to areas dominated by American companies. The American tech sector has a great, great future.

The names of the big winners are just going to change. For 2013 Qualcomm and Broadcom should do fine. Rotate out of Intel and Texas Instruments into more device-oriented plays like Nvidia and ARM Holdings. But as the general market advances along this front and you look for other investments for 2013 and beyond, buy American.

One final point. Careful readers will note I still am long Intel and Texas Instruments. I've gotten out of much of that Intel position, but I still have a bit of it. I'm getting out of TXN at the earliest opportunity. But I'm keeping the ARMH. Also, IBM has been very, very good for me. I'm keeping that, too.

Disclosure: I am long INTC, TXN, IBM, ARMH. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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