Intel Corp (INTC)

[DewDiligence]

Now Hot, WLAN Chips Could Cool Off Fast

By K.C. Swanson
Staff Reporter
01/31/2003 09:38 AM EST

http://www.thestreet.com/tech/kcswanson/10065790.html

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In a largely moribund semiconductor market, sales of wireless fidelity chips offer the tantalizing prospect of double-digit growth. But Wi-Fi is no safe haven. The fragmented business is poised for a shakeout over the next year as heavyweights start to push for a slice of the action and price competition heats up.

Anybody can see why chipmakers are eyeing Wi-Fi as a hot new end market. Sales of wireless LAN equipment grew about 27% in 2002, estimates Synergy Research Group, a market research firm. By comparison, the biggest market for chips – PCs -- saw revenue actually fall by around 9% last year.

But it was too good to last long. As big chip players start piling into wireless LAN, commoditization is in the offing. Along the way, the small fry who've pioneered the technology are in for a squeeze.

That pressure can already be seen at the likes of Intersil, currently the market leader in WLAN chips. In December, the company warned that revenue would fall below guidance because of weaker-than-expected WLAN revenues.

The problem isn't with demand for WLAN, which is clearly rising. It's that revenues are under pressure as companies battle it out for market share, forcing painful declines in average selling prices. "The primary reason for the revenue decrease [at Intersil] was because of the ASPs dropping dramatically," says John Chang, a senior analyst at Allied Business Intelligence.

The issue for a company like Intersil, which boasts a well-regarded analog business, is "whether the number of competitors moving into the market and rapid commoditization is going to make this a business you don't necessarily want to be in," explains Bobby Burleson, an analyst at Investec with a hold rating on the stock.

Heavyweights Heading In

Big-pocketed rivals moving into the area include Intel and Texas Instruments. Though Intel doesn't have its own 802.11 chips yet -- following a delay, they're scheduled to come out later this year -- it's expected to rank in the top three in terms of market share by the close of this year or by 2004. Texas Instruments, which claimed $8.4 billion in revenue last year, stands to be another powerful contender. Having only started shipping wireless LAN products last spring, it's also focused on ramping up the business.

In light of growing competition, industry watchers are forecasting a wave of consolidation and acquisitions. The PC market "is not big enough for the 30 IC vendors it currently has," says Chang. "The larger notebook guys, companies like Dell, Toshiba and IBM, will look to buy chipsets from large vendors." He expects smaller outfits to turn to niche markets such as home entertainment -- helping establish wireless networks between a television and VCR, for example.

To put the might of newcomers in perspective, consider that Intel posted revenue of nearly $27 billion last year, a sum many times the total market for wireless LAN equipment -- less than $2 billion, projecting an annual run rate based on third-quarter sales.

But it's also clear why Intel wants to grab a piece of a market that's enjoying strong growth, since its revenue climbed a mere 1% last year. It can boost the appeal of its core microprocessor products by integrating WLAN capabilities into the chips.

Yet the heightened competition is bound to increase pressure on selling prices, which have already suffered sizeable dropoffs. At IDC, analyst Ken Furer estimates that the price of an 802.11a chipset has dropped by about $10, from around $35 six or seven months ago.

Wireless LAN is "in its excitement stage and it's growing, but just like anything, it will mature and flatten out," says Furer. That's not happening just yet, he explains, because there's been a shift to relatively more expensive versions of 802.11, which offer higher access speeds. Though those prices are falling, too, they're high enough to offset some of the price fall-off that's already occurred in the cheaper version of wireless LAN chips.

But the higher-priced silicon "is going to come down the way everything has come down," predicts Furer.

Going the Way of the Modem

To get a bead on where wireless LAN chips are headed, think back on 56K modems, advises Chang. Early on, consumers could buy the modems from U.S. Robotics. But within a year or two, computer makers started embedding them in high-end notebooks, and gradually the modems became ubiquitous. "Now you don't talk about 56K modems as an industry. Essentially that's where WLAN is headed now," he says.

The difference, he adds, is that the spread of modems took about five to seven years. "But now it's happening at a much faster pace, because we as users are already used to broadband and wireless. And the commoditization is happening much faster, too."

In fact, from an investment stance, some would argue that the service side of Wi-Fi boasts better moneymaking prospects than hardware. Apax Partners, a private equity investment group that manages $11 billion for institutional investors, is helping to bankroll a joint venture between Intel, IBM and AT&T to create a nationwide Wi-Fi network -- named Cometa -- by outfitting up to 20,000 access points in 100 top markets.

The venture is expected to begin generating cash within a year by selling a subscription service to businesses through telecom providers. In theory at least, businesses would gain from a productivity boost if their employees could more easily access the Internet in places such as airports and hotels.

To be sure, businesses haven't seemed too eager lately to shell out for Wi-Fi connections at the office. Enterprise sales of equipment have been negative to flat for about the last three quarters, notes Aaron Vance, an analyst for Synergy. Growth has come from the consumer side, driven by broadband penetration and falling prices.

But the Cometa scenario assumes penny-pinching companies wouldn't have to shell out money on IT equipment themselves, since the venture would have already fitted out access points. And before long, enterprise laptops will be likely to contain embedded Wi-Fi silicon (though in the beginning, businesses would have to buy cards for the computers to make the service work).

The idea is that subscriptions to a Wi-Fi network would generate recurring revenue -- unlike hardware, in which sales of chips and equipment would be a one-time event. "We think this is an extremely interesting opportunity in the community services business -- one of the only ones we've seen in a long time to get very excited about," says Ted Schell, a partner at the firm.
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[FWIW: I have avoided investing in any companies whose fortunes are too-strongly wedded to the commercial uptake of WiFi --Dew]