The semiconductor assembly and test services (SATS) industry has been hit hard by the semiconductor inventory overhang, as well as a slowdown in demand for PCs and cell phones. Wall Street has taken notice, with shares of SATS companies now trading at 20 percent to 40 percent of their prices earlier this year. While we believe that the industry's issues are real, we are confident that they are temporary, with SATS companies well positioned for long-term growth, despite today's issues. Excess Inventory Many contract manufacturers built up excess inventory over the last several quarters as they tried to protect themselves against the supply shortages they faced in a variety of component areas last year. With the easing of supply, contract manufacturers and OEMs have taken the opportunity to improve their inventory positions. Late last year, it became increasingly clear that semiconductor inventories were being worked off. The prevailing question on Wall Street is how long this excess inventory reduction will take. We expect that inventory levels should be normalized in the second calendar quarter, assuming that we don't go into a global recession. If we are, in fact, entering a protracted semiconductor industry slowdown, we expect IDMs to cut spending on packaging technology, placing SATS companies in a far better competitive position when growth returns. Compounding the inventory woes is a weakening in end-market demand for PCs and cell phones. In December, Apple, Compaq, Dell and Gateway all warned of slackening demand. This follows multiple downward revisions for cell phone consumption last year. Taken together, these factors all point to SATS companies performing below expectations. And while the misses, in some cases, may be modest, Wall Street often punishes companies mercilessly for even slight misses-something we believe often creates excellent long-term buying opportunities. In November, both ASAT and ChipPAC lowered their growth expectations, citing some weakness in the PC and wireless markets, and the workdown of excess semiconductor inventories in the channel and at contract manufacturers. Rebound Due We are confident that each of these companies will rebound this year. While these companies are trading as if the semiconductor cycle is over, we remain confident that this is merely a mid-cycle, one- to two-quarter pause in a protracted cyclical upturn. Even if we are wrong in our optimism about the semiconductor market's strength, we believe that SATS companies are still likely to achieve strong growth. Why? Because of the power of the outsourcing trend. We continue to feel that the move to smaller, faster and more thermally demanding packages will require semiconductor companies to partner with packaging specialists. At its analyst meeting, Nokia predicted that by 2002 the number of web-connected wireless handsets would exceed the number of PCs worldwide. This projection fits exactly into the sweet spot of SATS companies, with ICs requiring high-performance packaging. While Nokia shares rose on this news, this forecast was apparently unnoticed by investors in SATS companies. However, it will be this ongoing shift away from a PC-centric world to a web-enabled, communication-centric world that stands to benefit SATS industry leaders. So whether end markets grow rapidly or sluggishly, as long as packaging becomes increasingly complex, SATS companies stand to benefit. Furthermore, with time to market becoming increasingly important, IDMs need the flexibility and ongoing packaging technology development of SATS companies to remain at the leading edge. While near-term share price gains in SATS companies may be limited, we remain confident that once inventory levels are brought to "normal," SATS companies stand to have a strong 2001 and beyond, with commensurate price gains.
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