Joe Dancy writes for the Lone Star Growth Investor newsletter. The newsletter is free of charge and is delivered to subscribers via email on a regular basis. For additional subscription information, you may visit their web site at: http://members.aol.com/LSinvestor

September 17, 1998

Experiencing one of the most severe downturns in history, the semiconductor
industry has discovered how difficult it is to accurately forecast demand in
this sector. None-the-less, Wilf Corrigan, founder and chief executive of LSI
Logic Corp. and former CEO of Fairchild Semiconductor recently stated that he
expects the industry to rebound explosively next year -- thanks to an increase
in demand and a shortage of supply.

"This is the longest down cycle that we've had, and I've always felt you
should look on these down cycles as the hangover before the party. I think the
party will come sometime next year, maybe in the second or third quarter," he
said.

* Inventory Squeeze "Spring-Loads" System

Corrigan noted that one of the recent developments that makes forecasting
demand in this industry difficult is the so called "Dell effect." Companies in
the electronics industry are reducing inventory, building equipment to order.
Almost every part of the supply chain has been squeezed, spring-loading the
whole system for the recovery when it comes. As a result the recovery will be
very sharp according to Corrigan because there is no inventory cushion in the
system.

As an example, Compaq started the year with 12 weeks' worth of inventory - now
it is down to just over three weeks. With warehouse stock dwindling,
manufacturers will begin to purchase more electronic components if product
demand accelerates.

"There's no inventory in the system, and the Internet demand is doubling every
100 days" according to Corrigan. "The things that people want to do on the
Internet is probably over time going to force them to get more and more
sophisticated equipment (which will increase the demand for semiconductors)."

* Plant Shutdowns Reducing Supply

On top of the inventory squeeze, a number of plants are being shut down.
Siemens is shutting down two plants. Texas Instruments is getting out of the
DRAM business, taking capacity off-line. Fujitsu, Hitachi, Mitsubishi and
Motorola are the latest in a long line of chip makers closing fabs or
restructuring the semiconductor businesses. In South Korea Hyundai's and LG
Semicon's chip operations will be merged as part of a broad restructuring.

"It's a growing perception that the cutbacks by semiconductor makers are
starting to reduce overcapacity," NationsBanc Montgomery Securities Inc.
analyst Brett Hodess said. "If the overcapacity comes to an end, then
semiconductor makers will start to buy equipment again.

"DRAM pricing is marginally stronger right now than it has been for the last
several months," Hodess said, noting that DRAM prices are commonly used as a
barometer for by which to measure the semiconductor industry.

These factors, according to Lehman Brothers Inc. analyst Edward White, make
the long-term outlook for the semiconductor industry and its equipment makers
a little rosier. White stressed that these are long term trends, and "right
now, we're not seeing much of a pickup at all in the equipment business."

On the other hand, some analysts said the retrenchments will do little to
reduce the industry's overcapacity situation, since few leading-edge fabs are
expected to close.

* Demand Increasing

The usage of most types of semiconductors, including DRAM, continues to rise
through the present crisis. The problem is that prices, particularly of
commodity chips like DRAM, are falling.

Michael Murphy points out that under Moore's law every 18 months you get a new
generation of semiconductor technology. In three years, that is two
generations, so many of the plants that were around in 1995 are now
functionally obsolete.

Murphy believes the third and fourth quarters will be better than expected for
tech stocks because of improving industry fundamentals. "PC sales picked up as
soon as Windows 98 was available," he said, "and communications sales are
strong. Inventory is low on finished goods, as it is for components, and
business is better than everybody thought." As a result, analysts are raising
their estimates for technology companies for this quarter and offering a rosy
outlook through 1999 according to Murphy.

Murphy noted that semiconductor-equipment companies appear to offer a good
long-term value. Equipment prices have fallen 50 to 70% as chip makers,
struggling with overcapacity and pricing pressures, have put capital
expenditures on hold. "The question," said Murphy, "is how long companies can
go without buying equipment." He noted that the move to 0.18-micron geometries
and 12-inch wafers will require equipment transitions. "Everything has to be
replaced when wafer size changes, so we're up for some big equipment buys
after 1998, although this year is pretty much shot."

Indeed, Intel recently announced that it plans to begin the commercial
production of computer processors at 0.18 micron geometries in 1999. The
smaller circuits will result in faster and lower-cost chips. NationsBanc's
Hodess sees several top-tier chip makers, including Intel, IBM Corp. and
Motorola Inc., upgrading production processes in the first half of 1999, with
several smaller chip makers following suit later in the year.

* Model Portfolio - FSI International (FSII)

One of our Contributing Editors visited the Allen, Texas, FSI plant recently
on a sales call. He met with a purchasing agent and a couple of engineers. He
reported that they were generally upbeat longer term for the company, would
buy the stock at these prices, think that their products are still
technologically competitive, and think that once equipment upgrades begin it
will be a "stampede." The big question they have is when will the stampede
occur. Their most optimistic date was the middle of next year - but no-one
knows. But they did note that once one party begins to the upgrade cycle it
will be like yelling "free beer" at a campus party.

Also, Martin Whitman of the Third Avenue Value Fund noted in a recent CNN
interview (9/8/98) that he is focusing on the semiconductor equipment sector -
"well-capitalized companies where we're buying in now at far, far better
prices than we could ever get when we first staged venture capitalists,
financing startups."

Whitman noted that they are buying FSI International and others in the sector
since "they all have cash well in-excess of book liabilities" - none of them
sell above book value - and "when the depression is over, the next peak is
going to be better than the last peak."

"It's not rocket science to know the whole world has gone digital and demand
for chips is going to explode," Whitman said.

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