Hopes for a Christmas miracle in the chip sector took a hit Thursday night, as both Altera (Nasdaq:ALTR) and Texas Instruments (NYSE:TXN) revised their fourth quarter guidance lower, on widespread chip weakness. If there's a silver lining to this cloud, it may be in that both companies are seeing similar trends and both believe that the current state of industry shipments is unsustainable. Although more than a few investors have already burned their fingers looking for a turnaround, the next quarter could be the bottom of the cycle and may be pointing towards a sharper rebound in 2012.

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Altera Doubles Down
Altera had previously expected sequential revenue declines of 7 to 11% and analysts dutifully pegged their estimates at a 9% sequential decline. Now, though, in response to what management characterized as "widespread weakness," they are revising their expectations to a decline of 13 to 16%. Given that Altera's smaller competitor Lattice (Nasdaq:LSCC) also warned of worse-than-expected results, and guided for a similar 14 to 17% sequential decline, the idea of widespread weakness seems legitimate.

Curiously, though, management did state that they believe they are under-shipping relative to industry demand. In other words, end-users like Cisco (Nasdaq:CSCO), Juniper (Nasdaq:JNPR) and China Mobile (NYSE:CHL) are burning through their chip inventories and those of their distributors. While that is a reasonable enough strategy in times of uncertainty, and/or when working capital financing is more difficult, prior industry run-downs have led to double-sourcing and sharp spikes in orders, when conditions rebound. (For related reading on working capital, see The Working Capital Position.)

Texas Instrument Sees a Broad Downturn
TI's fourth quarter warning was surprisingly similar to Altera's. Texas Instruments management sees weakness pretty much everywhere in their business, apart from their OMAP business (processors for wireless devices). Before investors in companies like Broadcom (Nasdaq:BRCM) or Qualcomm (Nasdaq:QCOM) get too excited, though, they should remember that TI has recently secured OMAP design wins with companies like Samsung, Motorola, Amazon (Nasdaq:AMZN) and Barnes & Noble (NYSE:BKS), and may therefore be in position to grow much better than the overall market.

All in all, Texas Instruments' revision was more modest and the company is now looking for a 6% sequential revenue decline. That's not especially good news for others, like ON Semiconductor (Nasdaq:ONNN), Linear Technology (Nasdaq:LLTC) or Atmel (Nasdaq:ATML), but Texas Instruments joined Altera in expressing the viewpoint that chip companies are currently under-shipping demand.

Texas Instruments also offered one additional data point, suggesting that Chinese monetary policy was making it harder for distributors to get the financing they need to replenish inventory. That could be valuable information for investors in Xilinx (Nasdaq:XLNX); while the guidance from Altera and Lattice would strongly suggest Xilinx is in similar trouble, Xilinx does have about half the exposure to China as Altera. (For related reading, see How The U.S. Government Formulates Monetary Policy.)

The Last Markdown?
If Altera and Texas Instruments are seeing things clearly and the chip sector is indeed shipping at rates less than customer demand, that can only go on so long. These end users and distributors will ultimately have to replenish their inventories and past cycles suggest that they will over-order and multi-source to do so. By the same token, if the economy continues at an unimpressive clip and/or China remains insistent on squashing inflation, that recovery could stretch out a bit. (For related reading, see What You Should Know About Inflation.)

The Bottom Linet
There are plenty of attractively-priced chip stocks out there today. Aggressive investors may want to bet on the fourth quarter of 2011 as the washout in this cycle and look to take positions ahead of what could be a rebound year in 2012. Of course there are risks that the malaise continues, but risk is nothing new to semiconductor investors.

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

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