April 8, 2001

IONICS DOWNGRADE

I would like to publish my most recent Ionics report where I downgraded the issue. As usual, I would welcome constructive comments. Meanwhile, may I also take this opportunity to greet my dear friend Jojo, who is celebrating her 27th birthday today. Behave girl!

For most tech stocks in the US, the rationale then given for the continued bullishness by analysts was that new applications for chips and mobile devices were being created by the moment. With the diversification of use, tech stocks such as PC makers, Internet infrastructure providers, and software developers were deemed immune to the typical boom-bust cycle characterizing most industries.

The rationale was plausible of course. At this point, most companies are still drafting e-commerce plans, and demand would thus seem insatiable in the coming years. And this is just for your basic tech stocks.

The darlings within the industry are the contract manufacturers. In the US, major players like Solectron, Celestica and Flextronics typically grew by more than 30% every year, were profitable and were trading at 90+ PERs. Last year, only 15% of OEMs have started outsourcing. With the industry estimated at around $100bn already, the growth prospects were indeed astounding.

But truth to tell, no one really expected the shakeout in the US to be this drastic. Day after day, the Dow Jones and the Nasdaq were battered with news of profit warnings, manpower cuts, warehouse closures and worse, looming bankruptcies.

To a fault, the news reports were already self-fulfilling. With the weakness in the demand in some industries, some companies have been forced to scale down expansion plans. In doing so, suppliers and business partners of such companies would also have to scale down. The grand effect of course would be the massive scaling down of growth prospects of whole industries, unfortunately, including the contract-manufacturing sector. In fact, the same companies I mentioned with the erstwhile ridiculous PERs are the same companies announcing weak prospects for the year.

It is with this information that we suspect Ionics may also be reeling from the effects of the global technology slowdown. As further validation, we did a sweeping survey among Philippine- based companies within related industries. Indeed the slowdown has been felt, with one semiconductor company admitting that they are producing at half their normal capacity. Layoffs have begun and voluntary retirement packages are being dangled.

In light of these developments, we scaled down our expectations for ION. In general, we believe our estimates are now much more conservative. To a large extent however, the performance of ION is tied-up with Philips given their $1bn / year deal. Unfortunately, there have been news items of Philips likewise feeling the pinch of the US economy’s weakness. As such our estimates are based on a scaledown by Philips of the contract with ION. This may or may not happen so we chose a mid-ground in forecasting. Should Philips substantially decrease the contracted output or postpone the deal altogether, we believe this would be catastrophic for ION’s earning potential for the year. Given that even IBM, one of ION’s major clients, has likewise been cutting manpower could also be a bad omen. In any case, these are still just scenarios that could be better gauged once ION announces its first quarter earnings. Without such negative developments, ION could still pull off a very impressive year.

Nonetheless, we don’t believe that ION’s long-term viability is threatened as much as it’s short-term earnings are. With this in mind, we recommend a SHORT-TERM TECHNICAL BUY, a MID- TERM HOLD, and a LONG-TERM BUY on ION shares.