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Global Equity ResearchJune 28, 2006

Global GambitsThe Right Moves for Right Now

The following is a chapter from Global Gambits � The Right Moves for Right Now, dated June 28, 2006. This chapter is presented forconvenience, and should be read in conjunction with the full report and its analyst certifications and important disclosures. The full report isavailable on MorganMarkets.

Technology Hardwarechapter

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June 28, 2006

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Tech Hardware Handset Demand Drivers Remain Strong, but Inventory Adjustment for Semiconductors Highly Likely in 2H06 Key DriversSemiconductorsChris DanelyUS Semiconductors

• Downside risk to CY06 is clearly evident as industry utilization declined to 90% in 1Q06 from 92% in 4Q05.

• Lead times for several broad-based products such as discretes, analog, and microcontrollers are roughly 6-12 weeks, above the normal range of 4-8 weeks. Decreases in lead times should lead to order cancellations.

• Industry Y/Y unit growth rates have reached +20% levels, well above end-market unit growth rates and roughly close to historical peaks.

Yoshiharu Izumi Japan Semiconductors

• Monthly METI data show that logic IC inventories rose by as much as 79% Y/Y in October 2004, but the growth lost momentum because of inventory reductions; inventories declined Y/Y from May 2005 to January 2006. Inventories started to increase again in February. Concerns are likely to linger and valuations could be held back until a slowdown in inventory growth is apparent.

• For our base scenario, we see limited likelihood of unintended inventory build like 2H04 to occur again in 2H06. First, growth rate in shipments is still above inventories’ rate. Second, whereas end product manufacturers in 2004 were overly bullish about a demand boost from the Athens Olympic

Games and the start of growth for digital consumer electronics, in 2006, they are cautious about the US economic outlook and Microsoft’s postponement of the launch of Windows Vista to early 2007. Third, there has been some shakeout/consolidation among end product manufacturers.

Semiconductor Capital Equipment Jay Deahna US Semiconductor Capital Equipment

• Leading edge capacity remains very tight. Overall, chip industry utilization rates declined to 90% in 1Q06 from 92% in 4Q05, slightly lower than our expectation of flat Q/Q. A majority of the decline was due to a decrease in wafer starts for trailing edge applications. Utilization rates for leading edge and mainstream products remained near maximum levels; thus the likelihood of further capex growth is high, in our view.

• 2Q06 utilization should increase. We expect utilization rates to increase modestly in 2Q06 with strong foundry wafer start growth, driven by order increases from Fab-lite customers and communications and console-related products, offset partially by Intel reducing the 90nm CPU production. Historically, overall industry and foundry utilization rates trend directionally together, and the expectation of an increase in foundry utilization in 2Q06 enhanced by a conscious underspend by

Global Sector Coordinator

Bhavin Shah (852) 2800-8538 [email protected] J.P. Morgan Securities (Asia Pacific) Full sector coverage details on page 15

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many of the major foundry players bolsters our confidence that overall industry utilization rates will increase as well.

• Sustained cycle. We are “supply-siders”—meaning major cyclical swings are derived from overspending and underspending. Outside Flash and Intel, we see an underspend. We expect DRAM, Foundry, and IDM/logic to drive sustained capital spending growth post the Flash surge and forecast 10%+ capex growth in 2007E.

Computer Hardware Bill Shope, CFA US Hardware

• We believe enterprise hardware demand will exhibit normal seasonal patterns.

• But networked storage demand could represent a surprising source of strength.

Bhavin Shah Asia Pacific Technology Research

• PC demand to pick up in 2007. Introduction of Vista and 64-bit dual core processor should boost PC demand substantially in 1H07, in our view. However, consumers may hold off purchases until 1H07, which could suppress 2H06 demand. We expect PC unit growth to slow to 7-9% in 2006E but re-accelerate to 13-14% in 2007E.

Communication Equipment/Handsets Bhavin Shah Asia Pacific Technology Research

• Under both market share and margin pressure, Korean handset makers, due to a lack of presence in the low-end segment and relatively inefficient supply chain management, may be forced to increase outsourcing to Taiwan.

• Multi-media, mobile messaging and ultra low-end handsets will see a sharp increase in ultra slim form factors.

• Handset-related Asian stocks have corrected sharply due to concerns about order cuts in the handset market. While it is very likely that the component order growth rate may exceed end-demand, we remain positive about the handset market growing at 20%+ rate in 2006.

Ehud A. Gelblum, PhD US Communications Equipment & Data Networking • Handset market continues to produce robust growth. On

April 10, 2006, we raised our 2006 market unit growth forecast to 20.3% from 14.8% based on positive subscriber net add data, particularly in the emerging markets, and our checks at CTIA.

• In the wireline infrastructure market, we continue to like

the broadband access market best. Competition between service providers—cable versus telco—continues to become a reality, evidenced by the cable MSOs’ increasing emphasis on VoIP, ever higher speed broadband and their wireless deal with Sprint, and the continued FTTx progress at Verizon and AT&T.

• Benefiting the entire optical food chain. An increase in data

traffic in the inter-central office metro area driven by video services and wireless data also appear to continue to spark life into the optical transport market.

• Outlook for the wireless infrastructure market remains

decidedly mixed. While Cingular is spending in earnest on its 3G rollouts, total spending at Cingular should be relatively flat this year while Verizon and Sprint have moved past the “NFL city” upgrade phase of their EV-DO builds. On the flip side, however, capacity spending in the North American wireless market should continue to run strongly. While operators in emerging markets are spending on wireless equipment to bring the “killer app” of voice telephony to most of the

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world’s population for the first time, pricing remains brutal and competition fierce, potentially pressuring vendor margins.

Our Non-Consensus Views Semiconductors Chris Danely US Semiconductors

• Focus on lead time changes as inventories seem only slightly above average compared to previous cycles.

• We expect overall PC sector weakness in CY06 due to the Vista delay and increasing price war among PC semiconductor companies.

Yoshiharu Izumi Japan Semiconductors

• Industry consolidation not a success. Hitachi’s effort to establish a joint foundry has failed to attract backers, and has resulted in the project being stalled, which is not surprising since we had expected six months ago that government-led chip industry consolidation would fail.

• Our picks. An investment idea, albeit a non-consensus view, is UMC Japan, which we think will turn profitable in 4Q06 due to improved sales mix, and a decline in depreciation. We also like Elpida Memory, Toshiba, and Nissin Electric as they will likely gain global market share for their key products.

Semiconductor Capital Equipment Jay Deahna US Semiconductor Capital Equipment

• Equipment stocks look attractively valued and technically oversold. Based on the current cycle and our estimated normalized P/E and P/B multiple, we see equipment stocks as very attractive from a fundamental valuation perspective. We also believe they are technically oversold.

• Sustained memory spending. In our ‘Next Wave Memory Spending’ thesis last July, we reiterated our belief that memory is in a 3+ year expansion phase similar to the mid-1990s, with multiple end-market drivers, not just one (i.e., PCs). DRAM capex is down this year and Flash is up. Assuming Flash capacity remains in Flash, we continue to see a major DRAM expansion phase extending the memory spending cycle starting later this year and continuing till deep next year.

• Lithography call. We expect the photolithography segment to materially outgrow the wafer Fab equipment industry over the next five years due to superior ASP increases, adoption of immersion tools, and double exposure techniques, and reduced competition. Our report in early April, “Arms Race is Brewing – ASML is the Primary Weapons Dealer” explains why chipmakers want to adopt the immersion lithography quicker than previously expected. Finally, over the past few weeks, we published 1Q06 earnings release-related reports where Cymer’s and ASML’s pre-earnings were in line with our expectations.

Computer Hardware Bill Shope, CFA US Hardware • The imaging market will likely remain under cyclical

pressure, as HP leverages its restructuring to capture market share in consumer inkjets.

• We believe PC demand is somewhat weaker than our original estimates coming into the quarter, but not quite as bad as current investor sentiment would suggest.

• With the likelihood of component prices declining at a faster rate in the coming months, particularly on the CPU side of the equation, we believe the largest PC OEMs will be able to grow at a faster rate than second-tier vendors.

• The iPod segment could gain some momentum in the second half due to seasonal strength and new products.

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Bhavin Shah Asia Pacific Technology Research

• Market share gains for notebook to slow down. It would be difficult for the Asian notebook brand to repeat the market share gain momentum in FY06 due to Dell’s aggressive pricing strategy and HP’s massively improved execution.

Communication Equipment / Handsets Bhavin Shah / Kevin Chang Asia Pacific Technology Research

• HTC rules. Despite the entry of a huge number of Taiwanese hardware companies in the converged handheld market, we believe none of them would become a serious threat to HTC at least within the next 12-18 months.

Ehud A. Gelblum, PhD US Communications Equipment & Data Networking

• We believe the handset market continues to be strong. Our latest checks suggest that the much-talked about order cancellations by Motorola have been limited to inputs for low-end models that are being phased out, and the fact that the company always over-orders and cancels overruns later, in order to remain flexible.

• Our least favorite market continues to be enterprise. We see little evidence of an outright upgrade cycle beyond ordinary replacement rates in the Ethernet switching and telephony/PBX markets.

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Semiconductors: Top Picks Company Key Financials Rationale and Catalysts LG Philips LCD Rating: Overweight Fiscal EPS (Local): Year-end Dec. Ticker: 034220 KS / 034220.KS 2005 2006E 2007E 1,514 518 4,094 Exchange: Korea Stock Exchange P/E (Calendar) Price (Local): W29,200 2006E 2007EMkt Cap (US$): 11.6 bn 56.3 7.1 Analyst: JJ Park EV/EBITDA (Calendar) Phone: (8-22) 758-5717 2006E 2007EEmail: [email protected] 4.8 2.5

• We believe the LCD TV market will show hyper growth, especially the 40-inch market, going forward. This will be the differentiating factor for the 7G+ camp such as LPL, in our view.

• Since the sudden and substantial margin improvement will not likely repeat in LCD TVs, top-line growth will be a driver for TFT-LCD companies’ earnings and share prices. We believe LPL would be the biggest beneficiary given its 7.5G line ramps.

• Given the 7.5G line ramps, we expect LPL’s TV contribution to total revenue to increase to 70% in 4Q06E compared to 43% for AUO. Since the PC panel segment is not making profit and has limited volume growth, the higher TV portion will drive LPL’s earnings growth in 2H06E.

• LPL’s stock is currently trading close to its floor value of W38,000, based on 12-month forward P/B. With strong earnings growth in 2H06E and 2007E, we expect the stock to gradually recover toward 2H06. We maintain our Overweight rating with a December 2006 target price of W45,000 implying 2.0x FY07E book. The risk to our target price is sudden or substantial changes in panel prices and slowdown in consumption in the developed market. Also, Won appreciation will remain a risk factor.

ASML Rating: Overweight Fiscal EPS (Local): Year-end Dec. Ticker: ASML NA / ASML.AS 2005 2006E 2007E 0.64 1.05 1.35 Exchange: Amsterdam Stock Exchange P/E (Calendar) Price (Local): €16.00 2006E 2007EMkt Cap (US$): 9.8 bn 15.5 12.1 Analyst: Jay Deahna EV/EBITDA (Calendar) Phone: (1-949) 224-4304 2006E 2007EEmail: [email protected] 9.5 7.7

• Immersion tool shipments in 2007 should substantially exceed consensus. It now appears that more than 15 chipmakers may be in volume production with immersion tools next year for 55nm or 45nm features, which would likely drive 60+ immersion tools shipments in 2007. Importantly, this is likely to drive a substantial installed base barrier to entry given ASML’s 1+ year lead in immersion, implying a ramp into several years of above average revenue and EPS growth and share gain.

• Assuming the adoption of double exposure lithography, which we previously wrote a report on (“Double Exposure at 32nm Should Drive Superior Secular Growth for Lithography Companies,” February 21, 2006), and more layers per device, the lithography segment of the wafer fab equipment industry could be greater than €7 billion in 2010. Hence, given its share gain momentum, ASML is very likely to double (or more) its sales from 2005 to 2010, implying a 15% revenue CAGR. Share gain, a substantially above-average ASP progression driven by advanced dry ArF, immersion ArF, EUV, and double exposure should all contribute to substantially above wafer fab equipment average revenue growth.

• We expect ASML to deliver superior secular EPS growth given its evolving business model and a declining share count. Management looks solid, the company’s competitive position is extremely impressive, and its valuation attractive, in our view, regardless of wherever the cycle is perceived to be at the moment.

Source: Company data, Bloomberg, JPMorgan estimates, JPMorgan SaVanT. Prices as of June 15, 2006.

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Semiconductors: Top Picks (cont’d) Company Key Financials Rationale and Catalysts Varian Semiconductor Equipment Rating: Overweight Fiscal EPS (Local): Year-end Sept. Ticker: VSEA US / VSEA 2005 2006E 2007E 0.99 1.63 2.24 Exchange: NASDAQ P/E (Calendar) Price (Local): US$31.54 2006E 2007EMkt Cap (US$): 1.8 bn 16.2 14.7 Analyst: Jay Deahna EV/EBITDA (Calendar) Phone: (1-949) 224-4304 2006E 2007EEmail: [email protected] 8.4 7.7

• We expect Varian’s high current share price to increase to the mid-40s in 2006, compared to 38% in 2005. We think customer wins at Intel, Sony, and Toshiba will be key drivers, with additional upside potential from IM Flash and AMD Dresden.

• Gross margins should rise steadily in 2006E on the back of rollouts of higher margin product upgrades. In addition, warranty and installation costs should come down as Varian moves up the learning curve in supporting new high current customers.

• Varian is on our JPMorgan US Analysts’ Focus List with a January 2007 price target of US$39, based on 18.1x our 2007E pro-forma EPS estimate of US$2.15. Risks to price target are slower-than-expected near/mid-term semiconductor industry fundamentals due to the potential for weak macro-economic, IT and consumer spending trends. From a company-specific perspective, failure to expand gross margins and execute volume proliferation of “design win” share gain are also key risks, in our view.


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PC, Hardware, Components: Top Picks Company Key Financials Rationale and Catalysts Apple Computer Rating: Overweight Fiscal EPS (Local): Year-end Sept. Ticker: AAPL US / AAPL 2005 2006E 2007E 1.39 2.11 2.90 Exchange: NASDAQ P/E (Calendar) Price (Local): US$59.38 2006E 2007EMt Cap (US$): 50.5 bn 28.1 20.5 Analyst: Bill Shope, CFA EV/EBITDA (Calendar) Phone: (1-212) 622-6607 2006E 2007EEmail: [email protected] 13.8 NA

• We believe the late boost in Intel-based Mac shipments last quarter and the introduction of an Intel-based consumer notebook should drive acceleration in Mac shipments this quarter and throughout the calendar year. This momentum should be supported by the completion of the Intel transition later this summer and market share gains due to Boot Camp.

• Seasonal strength and new products could bring some momentum back to the iPod segment. In particular, we continue to believe that a new, “true” video iPod and refreshed Nanos could stimulate growth in the latter part of the calendar year. This, coupled with a favorable pricing environment for storage media, could further boost Apple’s earnings and revenue momentum in the coming quarters.

• In our view, near-term risks to the Apple story are more than factored into the share price, and the potential Mac share gains in late calendar 2006 and beyond should begin to drive the stock going forward. This, coupled with our continued expectation for several new products in the coming months and a completion of the Intel hardware transition late in summer, suggest to us that the stock will outperform the peer group average considerably this calendar year. We reiterate our Overweight rating.

TDK Rating: Overweight Fiscal EPS (Local): Year-end Mar. Ticker: 6762 JP / 6762.T 2005 2006E 2007E 333.20 489.20 565.50 Exchange: Tokyo Stock Exchange P/E (Calendar) Price (Local): ¥8,170 2006E 2007EMkt Cap (US$): 9.9 bn 16.8 14.5 Analyst: Shoji Sato EV/EBITDA (Calendar) Phone: (81-3) 6736-8661 2006E 2007EEmail: [email protected] 6.5 5.6

• We believe the ¥13.8 billion operating loss in TDK’s recording media business in FY05 will improve to ¥1 billion operating profit in FY06 due to its restructuring including the close of European production facility.

• The MLCC production yield problem which TDK had in 1H FY05 has been solved; we believe the operating profit of the MLCC business will improve to ¥24 billion in FY06E from ¥15 billion in FY05.

• The Seagate acquisition of Maxtor is likely to cause a significant damage to TDK’s HDD head business. However, we estimate that this business will increase in Hitachi GST and Western Digital and will offset the decline of Maxtor’s business in the medium term.

• Our target price for April 2007 is ¥11,500, based on our FY06 EPS estimate of ¥489.2 multiplied by the sector average P/E ratio of 23x. As potential risk factors, we would cite inventory correction in electronic components, including HDD heads, and the possibility that the yen will strengthen beyond the level of ¥110/$ that the company assumes.


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PC, Hardware, Components: Top Picks (cont’d) Company Key Financials Rationale and Catalysts Wistron Rating: Overweight Fiscal EPS (Local): Year-end Dec. Ticker: 3231 TT / 3231.TW 2005 2006E 2007E 3.06 5.10 5.66 Exchange: Taiwan Stock Exchange P/E (Calendar) Price (Local): NT$33.00 2006E 2007EMkt Cap (US$): 1.2 bn 6.5 5.8 Analyst: Alvin Kwock EV/EBITDA (Calendar) Phone: (886-2) 2725-9866 2006E 2007EEmail: [email protected] 5.4 4.9

• Wistron is reaping the rewards of several sound strategic moves in the past years: (1) Spin-off from Acer in 2001 allowed it to diversify its client base and beef up notebook scale. (2) After building up its notebook PC scale, Wistron streamlined its manufacturing process by hiring operation experts from rivals in 2H05. (3) Effective diversification into non-PC areas such as handheld devices and game consoles.

• Wistron sets the stage for very strong growth in 2H06 on the back of: (1) high-volume HP consumer notebook models commencing from June; (2) recently upped XBox 360 rolling forecasts according to our channel check ; (3) more new project ramp in handheld devices, such as GPS, rugged PDA and portable TV. These drivers will also likely help Wistron continue to grow its earnings in FY07E despite lower notebook allocation from Dell. We also expect continuous margin expansion on the back of rising economies of scale and execution improvement.

• Our Dec-06 target price of NT$56 is based on our sum-of-the-parts valuation. Risks to target price are: (1) aggressive price competition among notebook brands leading to more cost squeeze among suppliers; and (2) NT dollar appreciation leading to margin contraction.


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Communication Equipment, Handsets: Top Picks Company Key Financials Rationale and Catalysts Cisco Systems Rating: Overweight Fiscal EPS (Local): Year-end Jul. Ticker: CSCO US / CSCO 2005 2006E 2007E 0.92 1.06 1.21 Exchange: NASDAQ P/E (Calendar) Price (Local): US$20.22 2006E 2007EMkt Cap (US$): 123.4 bn 17.3 15.1 Analyst: Ehud A. Gelblum, PhD EV/EBITDA (Calendar) Phone: (1-212) 622-6457 2006E 2007EEmail: [email protected] 10.7 9.4

• Following the acquisition of Scientific Atlanta, we believe Cisco should be able to participate in two new consumer-oriented service provider-based growth cycles—HDTV set-tops in the US and IPTV in the US and internationally—both of which should lead to top-line upside.

• We also believe 10% cost synergies across the board at SFA can lead to better margins than most people expect from the combination, driving potential upside to Cisco’s quarters in early FY07 and laying to rest the issue of its weakening gross margin line.

• As the focus of the story goes back to the top line, driven by HDTV and IPTV product cycles, SFA’s lower margin structure provides air-cover for Cisco to more aggressively price its own product lines, thereby driving faster revenue growth in the core. We expect to see multiples expand to a premium to the market multiple given the company’s strong cash flow and balance sheet and accelerating top line.

• It is important to note that our Overweight rating on Cisco is NOT predicated on growth in its core enterprise business, although there does appear to be a tailwind in the small/medium/commercial segment boosting the core business to the upper end of its 10-15% long-term growth rate.

High Tech Computer Rating: Overweight Fiscal EPS (Local): Year-end Dec. Ticker: 2498 TT / 2498.TW 2005 2006E 2007E 34.00 71.00 99.00 Exchange: Taiwan Stock Exchange P/E (Calendar) Price (Local): NT$890.00 2006E 2007EMkt Cap (US$): 9.9 bn 12.6 9.0 Analysts: Bhavin Shah / Kevin Chang EV/EBITDA (Calendar) Phones: (852) 2800-8538 / (886-2) 2725-9879 2006E 2007EEmails: [email protected] /

[email protected] 11.6 8.2

• Booming corporate e-mail market. • Mobile TV is going to become a big driver in FY07, in our view. • Strong demand for 3G converged handheld sets in Europe. • Our end-06 DCF-based target price is NT$1,329, at 18.9x employee stock bonus adjusted P/E for FY07E. Risks to our

target price are: (1) operators’ strategy in providing handset subsidies to drive data revenue; (2) competition between HTC and other major global players like Nokia, Motorola, Samsung and Research in Motion; (3) high correlation between share price movement and monthly sales volatility; and (4) general demand outlook for the global handset industry.


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Communication Equipment, Handsets: Top Picks (cont’d) Company Key Financials Rationale and Catalysts Largan Precision Rating: Overweight Fiscal EPS (Local): Year-end Dec. Ticker: 3008 TT / 3008.TW 2005 2006E 2007E 15.10 35.10 49.90 Exchange: Taiwan Stock Exchange P/E (Calendar) Price (Local): NT$640.00 2006E 2007EMkt Cap (US$): 2.3 bn 18.3 12.8 Analysts: Bhavin Shah / Eric Liang EV/EBITDA (Calendar) Phones: (852) 2800-8538/ (886-2) 2725-9867 2006E 2007EEmails: [email protected] /

[email protected] 18.9 12.6

• Rapidly rising camera penetration and continuous resolution migration. We expect the camera penetration rate to expand to 61% in FY07E from 47% in FY05. Resolution migration should continue and the shipment mix of megapixel models should reach 60%+ in FY07E.

• Solid technology leadership. With the 2-3 quarter technology gap, we expect Largan to maintain a strong leadership position over its peers in the coming 2-3 years.

• Further market share gain potential. We expect Largan to benefit from megapixels migration and an all-plastic lens design trend. Largan should expand market share to 38% in FY07, based on our estimates.

• Our end-06 DCF-based price target is NT$832, which would put the stock at 23.7x/16.7x FY06/07E P/E (29.4x/19.4x employee bonus adjusted P/E). Risks to our price target include global demand/inventory for camera phones, and the speed of migration to high resolution camera handsets, price pressure from camera module makers, Largan’s ability to improve manufacturing yield to sustain margin and offset ASP erosion. Our earnings forecasts and therefore price target are highly sensitive to these factors which can affect our shipment, ASP and margin assumptions.


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Semiconductors: Stocks to Underweight Company Key Financials Rationale and Catalysts E-Ton Rating: Underweight Fiscal EPS (Local): Year-end Dec. Ticker: 3452 TT / 3452.TW 2005 2006E 2007E 12.4 22.1 39.1 Exchange: Taiwan Stock Exchange P/E (Calendar) Price (Local): NT$705.00 2006E 2007EMkt Cap (US$): 0.6 bn 22.1 39.1 Analyst: Hsin Yin Hsieh EV/EBITDA (Calendar) Phone: (886-2) 2725-9875 2006E 2007EEmail: [email protected] 27.1 15.2

• Inflated expectations. The solar market growth in 2006 is likely to be restricted to <15% versus 34% in 2005 due to severe shortage of the key input, polysilicon. The polysilicon shortage is unlikely to ease off by 2008, in our view.

• Potential margin erosion. Polysilicon prices are expected to rise by 15-20% this year while module prices have reached the ceiling imposed by government subsidies. It is difficult for E-Ton to pass on all material price increases to customers. In addition, competition from new entrants in Asia would trigger pricing pressure in 2007. From a longer-term perspective, we doubt E-Ton’s high ROE/ROIC is sustainable beyond 2008 given the low entry barriers.

• Stabilizing/declining oil prices. Solar stocks have a high correlation with oil prices. Our oil analysts forecast crude oil prices to decline to US$65 per barrel in 4Q06.

• Our DCF-based Dec-06 price target of NT$686 is based on 10 years of 22.5%+ revenue growth. We believe the stock should see a correction in 2H06. Key upside risks to our price target are: (1) better-than-expected wafer supply, (2) faster advances in technology, and (3) rising oil prices.

VIA Technologies Rating: Underweight Fiscal EPS (Local): Year-end Dec. Ticker: 2388 TT / 2388.TW 2005 2006E 2007E (0.66) (0.62) NM Exchange: Taiwan Stock Exchange P/E (Calendar) Price (Local): NT$28.75 2006E 2007EMkt Cap (US$): 1.2 bn NM NM Analyst: Alvin Kwock EV/EBITDA (Calendar) Phone: (886-2) 2725-9866 2006E 2007EEmail: [email protected] NM NM

• We believe the stock’s rally was driven by three unsustainable drivers: (1) net income turnaround in 4Q05/1Q06; (2) early recognition of CPU revenue; and (3) AMD’s share gain.

• We believe the stock has overshot, and we expect a sharp revenue decline in June post the end of Intel’s CPU license and the return to loss in 3Q06 could catalyze a severe correction in the coming months.

• In our view, the fair value of the stock is NT$10-15, or 1x BVPS, as it is operating at negative EVA. Our P/B-based Dec -06 price target is NT$15. Risks to target price are: (1) stronger-than-expected PC demand leading Intel to resume chipset outsourcing; and (2) AMD share gain.


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PC, Hardware, Components: Stocks to Underweight Company Key Financials Rationale and Catalysts Pentax Rating: Underweight Fiscal EPS (Local): Year-end Mar. Ticker: 7750 JP / 7750.T 2005 2006 2007E 28.20 6.50 22.70 Exchange: Tokyo Stock Exchange P/E (Calendar) Price (Local): ¥573.00 2006E 2007EMkt Cap (US$): 0.7 bn 88.1 25.2 Analyst: Hisashi Moriyama EV/EBITDA (Calendar) Phone: (81-3) 6736-8601 2006E 2007EEmail: [email protected] 10.0 8.3

• Pentax is suffering from increased competitive pressure in its endoscope business (70% of operating profit) due to new products by Olympus. We expect it to feel the pressure from that as well as from a relative latecomer to the market, Fuji Photo Film, as it begins to catch up.

• In the optical components business, which accounts for 30% of Pentax’s OP, we still cannot factor in any blue-ray or next generation optical pick-up lenses, so the falling prices of DVD-use lenses are likely to continue to pressure the segment.

• The digital camera business is recovering from the red, but we believe the entry of Sony into the high-margin digital SLR business is likely to hurt Pentax’s competitive position. This new development raises the possibility of an OP miss, in our opinion.

Sun Microsystems Rating: Underweight Fiscal EPS (Local): Year-end Jun. Ticker: SUNW US / SUNW 2005 2006E 2007E (0.03) (0.17) (0.03) Exchange: NASDAQ P/E (Calendar) Price (Local): US$4.35 2006E 2007EMkt Cap (US$): 15.2 bn NM NM Analyst: Bill Shope, CFA EV/EBITDA (Calendar) Phone: (1-212) 622-6607 2006E 2007EEmail: [email protected] 23.3 NA

• We are encouraged by Sun’s recently announced restructuring plans and its attempt to become more transparent with investors. Nevertheless, we believe Sun will need to take more aggressive action to generate sustainable profit improvements.

• Our below-consensus estimates were in line with Sun’s low- to mid-single digit revenue growth and stable gross margin targets even before the restructuring plans were announced. Even this may be a lofty target given the persistent secular challenges facing the company. On a positive note, however, Sun’s management suggested that it would consider further reductions if the company’s growth or gross margin profile were to deteriorate. This may be required by the time the company reaches the end of the next fiscal year.

• Overall, we would have to optimistically assume 5% revenue growth off of our calendar 2006 revenue estimate and 4% operating margins to achieve a 20x multiple for Sun’s stock at current levels (excluding options expense and adjusting for cash). This compares to the peer group average of 19x. In reality, given Sun’s secular challenges, even a multiple that is in line with the peer group average may be too aggressive. As a result, we maintain our Underweight rating, and we suspect the shares will come under pressure as investor expectations become more rational in the coming quarters.


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Communication Equipment, Handsets: Stock to Underweight Company Key Financials Rationale and Catalysts Inter-Tel Rating: Underweight Fiscal EPS (Local): Year-end Dec. Ticker: INTL US / INTL 2005 2006E 2007E 1.02 1.10 1.20 Exchange: NASDAQ P/E (Calendar) Price (Local): US$21.76 2006E 2007EMkt Cap (US$): 0.6 bn 18.3 16.7 Analyst: Ehud Gelblum, PhD EV/EBITDA (Calendar) Phone: (1-212) 622-6457 2006E 2007EEmail: [email protected] 6.4 5.9

• We recently downgraded Inter-Tel to Underweight from Neutral as we see the company facing an increasingly competitive market and difficulty transitioning to IP-centric products, and we believe these challenges are made more daunting by the distraction from the ongoing uncertainty regarding former CEO Mihaylo’s takeover bid.

• We believe that the board is unlikely to accept Mihaylo’s US$22.50 buyout given that they recently disposed him as CEO and the US$22.50 represents just a 1% premium to the average close over the last two years.

• At 18.1x our 2007 EPS estimate of US$1.20 (excluding options expense), Inter-Tel trades at a premium to peers and to the S&P 500 despite historically trading at a 20%+ discount.

• For former CEO Mihaylo to pay much more than his current offer of US$22.50 in the face of likely just 3% top-line growth in 2006E and 4% in 2007E and rising product transition costs, appears unreasonable irrespective of the company’s current cash flow and cash balance. And if the buyout does not occur, we would expect the shares to give back the recent acquisition premium.


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JPMorgan Global Technology Hardware Team – Research Equity Research Credit Research Bhavin Shah Global Sector Coordinator

Components, Contract Manufacturing and Consumer Electronics

Computing and Storage Devices Semiconductors Telecom Equipment – Wireline and Data Networking

Telecom Equipment - Wireless

Gokul Hariharan Tom Dinges, CFA, Coordinator Bill Shope, CFA Coordinator Chris Danely, Coordinator Ehud Gelblum, Coordinator Johnny Chan, CFA, Coordinator Americas Americas Americas Americas Americas Americas United States Tom Dinges,

CFA Jason Gursky Paul Coster, CFA Sameer Doctor Amy Nam Lauren Suding

United States Bill Shope, CFA Liz Borbolla Mark Moskowitz (Storage Devices)

United States Jay Deahna Philip Lee Christopher R Blansett Chris Danely Shawn Webster Sameer Parab Hayal Koc Bill Lewis

United States

Ehud Gelblum Kim Anderson, CFA Steve O'Brien

United States

Ehud Gelblum Kim Anderson, CFA Steve O'Brien

United States

Sara Rouf (HG/HY-Technology) Gregg Brody (HG/HY-Technology)

EMEA Pan Europe

David Caldana (HG/HY) Diana Tatarchuk (HG/HY)

Asia Pacific Asia Pacific Asia Pacific Asia Pacific Asia Pacific Asia Pacific Pan Asia Johnny Chan,

CFA Pan Asia Johnny Chan, CFA

Pan Asia Bhavin Shah

Hsin-Yin Hsieh Pan Asia

Johnny Chan, CFA

Pan Asia

Johnny Chan, CFA

Japan

Mana Nakazora

Japan

Hiroshi Takada Shunsuke Tsuchiya Shoji Sato Yoshiharu Izumi Kenji Yasui

Japan Yoshiharu Izumi Kenji Yasui Shoji Sato

Japan

Yoshiharu Izumi Miho Funada Kenji Yasui Hisashi Moriyama David Jacobson

Japan

Yoshiharu Izumi Kenji Yasui Shoji Sato

Japan Yoshiharu Izumi Shoji Sato

Singapore Anuj Sehgal Singapore Anuj Sehgal Singapore Anuj Sehgal India Charles Guo

HK/China Charles Guo Sanjay Chawla

South Korea Sung Namgoong Dayoung Seo

Taiwan

Alvin Kwock Kevin Chang

South Korea JJ Park Dayoung Seo Yun Sun Choi Sung Namgoong

Singapore Anuj Sehgal Malvika Agarwal

Taiwan

Alvin Kwock Liang-Chun Lin Gokul Hariharan Roland Shu

South Korea JJ Park

Taiwan Kevin Chang Eric Liang

June 28, 2006


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Companies Recommended in This Report (prices as of COB 20 June 2006 except where noted) Apple Computer Inc. (AAPL/$57.20 [19-June-2006]/Overweight), ASML (ASML/$19.40 [19-June-2006]/Overweight), ASML (ASML.AS/€15.70 [19-June-2006]/Overweight), Cisco Systems (CSCO/$19.82 [19-June-2006]/Overweight), Elpida Memory (6665) (6665.T/¥4,680/Overweight), E-Ton Solar Tech Co Ltd (3452.TWO/NT$680.00/Underweight), High Tech Computer (HTC) (2498.TW/NT$770.00/Overweight), Inter-Tel Inc (INTL/$21.45 [19-June-2006]/Underweight), Largan Precision (3008.TW/NT$562.00/Overweight), LG Philips LCD (034220.KS/W28,300/Overweight), Nissin Electric (6641) (6641.T/¥505/Overweight), Pentax (7750) (7750.T/¥586/Underweight), Sun Microsystems (SUNW/$4.14 [19-June-2006]/Underweight), TDK (6762) (6762.T/¥8,430/Overweight), Toshiba (6502) (6502.T/¥711/Overweight), UMC Japan (6939) (6939.Q/¥40,050/Overweight), Varian Semiconductor Equipment (VSEA/$31.02 [19-June-2006]/Overweight), VIA Technologies Inc (2388.TW/NT$27.70/Underweight), Wistron Corporation (3231.TW/NT$34.90/Overweight)

Analyst Certification: The research analyst who is primarily responsible for this research and whose name is listed first on the front cover certifies (or in a case where multiple research analysts are primarily responsible for this research, the research analyst named first in each group on the front cover or named within the document individually certifies, with respect to each security or issuer that the research analyst covered in this research) that: (1) all of the views expressed in this research accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research analyst’s compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst in this research.

Important Disclosures

• Market Maker: JPMSI makes a market in the stock of Apple Computer Inc., ASML, Cisco Systems, Inter-Tel Inc, Sun Microsystems, Varian Semiconductor Equipment.

• Market Maker/ Liquidity Provider: JPMSL and/or an affiliate is a market maker and/or liquidity provider in ASML. • Lead or Co-manager: JPMSI or its affiliates acted as lead or co-manager in a public offering of equity and/or debt securities for Cisco Systems, Elpida

Memory (6665), Toshiba (6502), Wistron Corporation within the past 12 months. • Analyst Position: The covering analyst, research associate, or member(s) of their respective household(s) have a long position in the securities of ASML,

Cisco Systems. • Beneficial Ownership (1% or more): JPMSI or its affiliates beneficially own 1% or more of a class of common equity securities of ASML, TDK (6762). • Client of the Firm: Apple Computer Inc. is or was in the past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the company non-

investment banking securities-related service. ASML is or was in the past 12 months a client of JPMSI. Cisco Systems is or was in the past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the company investment banking services, non-investment banking securities-related service and non-securities-related services. Elpida Memory (6665) is or was in the past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the company non-investment banking securities-related service and non-securities-related services. Inter-Tel Inc is or was in the past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the company non-investment banking securities-related service and non-securities-related services. LG Philips LCD is or was in the past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the company investment banking services and non-investment banking securities-related service. Sun Microsystems is or was in the past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the company investment banking services. TDK (6762) is or was in the past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the company non-investment banking securities-related service. Toshiba (6502) is or was in the past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the company investment banking services, non-investment banking securities-related service and non-securities-related services. Varian Semiconductor Equipment is or was in the past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the company non-investment banking securities-related service and non-securities-related services. Wistron Corporation is or was in the past 12 months a client of JPMSI.

• Investment Banking (past 12 months): JPMSI or its affiliates received in the past 12 months compensation for investment banking services from Cisco Systems, LG Philips LCD, Sun Microsystems, Toshiba (6502).

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• Investment Banking (next 3 months): JPMSI or its affiliates expect to receive, or intend to seek, compensation for investment banking services in the next three months from Cisco Systems, Elpida Memory (6665), LG Philips LCD, Sun Microsystems, Toshiba (6502), Wistron Corporation.

• Non-Investment Banking Compensation: JPMSI has received compensation in the past 12 months for products or services other than investment banking from Apple Computer Inc., Cisco Systems, Elpida Memory (6665), Inter-Tel Inc, LG Philips LCD, TDK (6762), Toshiba (6502), Varian Semiconductor Equipment. An affiliate of JPMSI has received compensation in the past 12 months for products or services other than investment banking from Apple Computer Inc., ASML, Cisco Systems, Inter-Tel Inc, LG Philips LCD, Sun Microsystems, TDK (6762), Toshiba (6502), Varian Semiconductor Equipment, Wistron Corporation.

Price Charts for Compendium Reports: Price charts are available for all companies under coverage for at least one year through the search function on JPMorgan's website https://mm.jpmorgan.com/disclosures/company or by calling this toll free number (1-800-477-0406).

Explanation of Equity Research Ratings and Analyst(s) Coverage Universe: JPMorgan uses the following rating system: Overweight [Over the next six to twelve months, we expect this stock will outperform the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Neutral [Over the next six to twelve months, we expect this stock will perform in line with the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Underweight [Over the next six to twelve months, we expect this stock will underperform the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] The analyst or analyst’s team’s coverage universe is the sector and/or country shown on the cover of each publication. See below for the specific stocks in the certifying analyst(s) coverage universe.

Coverage Universe: Bhavin Shah: Chartered Semiconductor (Singapore) (CSMF.SI), Chartered Semiconductor (US) (CHRT), Foxconn Technology (2354.TW), High Tech Computer (HTC) (2498.TW), Largan Precision (3008.TW), TSMC (2330.TW), UMC (2303.TW)

JPMorgan Equity Research Ratings Distribution, as of April 3, 2006

Overweight (buy)

Neutral (hold)

Underweight (sell)

JPM Global Equity Research Coverage 40% 42% 18% IB clients* 45% 47% 39% JPMSI Equity Research Coverage 35% 50% 15% IB clients* 63% 57% 46% *Percentage of investment banking clients in each rating category. For purposes only of NASD/NYSE ratings distribution rules, our Overweight rating falls into a buy rating category; our Neutral rating falls into a hold rating category; and our Underweight rating falls into a sell rating category.

Valuation and Risks: Equity Research company notes and reports include a discussion of valuation methods used, including methods used to determine a price target (if any), and a discussion of risks to the price target.

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Analysts’ Compensation: The equity research analysts responsible for the preparation of this report receive compensation based upon various factors, including the quality and accuracy of research, client feedback, competitive factors, and overall firm revenues, which include revenues from, among other business units, Institutional Equities and Investment Banking.

Other Disclosures

Options related research: If the information contained herein regards options related research, such information is available only to persons who have received the proper option risk disclosure documents. For a copy of the Option Clearing Corporation’s Characteristics and Risks of Standardized Options, please contact your JPMorgan Representative or visit the OCC’s website at http://www.optionsclearing.com/publications/risks/riskstoc.pdf.

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Country and Region Specific Disclosures

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U.K. and European Economic Area (EEA) : Issued and approved for distribution in the U.K. and the EEA by JPMSL. Investment research issued by JPMSL has been prepared in accordance with JPMSL’s Policies for Managing Conflicts of Interest in Connection with Investment Research which can be found at http://www.jpmorgan.com/pdfdoc/research/ConflictManagementPolicy.pdf. This report has been issued in the U.K. only to persons of a kind described in Article 19 (5), 38, 47 and 49 of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001 (all such persons being referred to as "relevant persons"). This document must not be acted on or relied on by persons who are not relevant persons. Any investment or investment activity to which this document relates is only available to relevant persons and will be engaged in only with relevant persons. In other EEA countries, the report has been issued to persons regarded as professional investors (or equivalent) in their home jurisdiction Germany : This material is distributed in Germany by J.P. Morgan Securities Ltd. Frankfurt Branch and JPMorgan Chase Bank, N.A., Frankfurt Branch who are regulated by the Bundesanstalt für Finanzdienstleistungsaufsicht. Australia : This material is issued and distributed by JPMSAL in Australia to “wholesale clients” only. JPMSAL does not issue or distribute this material to “retail clients.” The recipient of this material must not distribute it to any third party or outside Australia without the prior written consent of JPMSAL. For the purposes of this paragraph the terms “wholesale client” and “retail client” have the meanings given to them in section 761G of the Corporations Act 2001. Hong Kong : The 1% ownership disclosure as of the previous month end satisfies the requirements under Paragraph 16.5(a) of the Hong Kong Code of Conduct for persons licensed by or registered with the Securities and Futures Commission. (For research published within the first ten days of the month, the disclosure may be based on the month end data from two months’ prior.) J.P. Morgan Broking (Hong Kong) Limited is the liquidity provider for derivative warrants issued by J.P. Morgan International Derivatives Ltd and listed on The Stock Exchange of Hong Kong Limited. An updated list can be found on HKEx website: http://www.hkex.com.hk/prod/dw/Lp.htm. Korea : This report may have been edited or contributed to from time to time by affiliates of J.P. Morgan Securities (Far East) Ltd, Seoul branch. Singapore : JPMSI and/or its affiliates may have a holding in any of the securities discussed in this report; for securities where the holding is 1% or greater, the specific holding is disclosed in the Legal Disclosures section above. India : For private circulation only not for sale.

General: Additional information is available upon request. Information has been obtained from sources believed to be reliable but JPMorgan Chase & Co. or its affiliates and/or subsidiaries (collectively JPMorgan) do not warrant its completeness or accuracy except with respect to any disclosures relative to JPMSI and/or its affiliates and the analyst’s involvement with the issuer that is the subject of the research. Opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients. The recipient of this report must make its own independent decisions regarding any securities or financial instruments mentioned herein. JPMSI distributes in the U.S. research published by non-U.S. affiliates and accepts responsibility for its contents. Periodic updates may be provided on companies/industries based on company specific developments or announcements, market conditions or any other publicly available information. Clients should contact analysts and execute transactions through a JPMorgan subsidiary or affiliate in their home jurisdiction unless governing law permits otherwise.

Revised April 3, 2006.

Copyright 2006 JPMorgan Chase & Co. All rights reserved.

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