The Semiconductor Industry serves as a driver, enabler and
indicator of technological progress. Developments in the industry
determine the way we work, transport ourselves, communicate,
entertain ourselves and respond to our environment. The PCs we work
on, the cars we drive, the phones we communicate with, the
electronic gadgets on which we watch movies, listen to music and
play games on, and the planes and weapons used to transport or
protect us use semiconductor devices.
As environmental issues have become more of a concern today,
semiconductor devices are being made to reduce power consumption,
reduce heat dissipation, capture solar energy, create more
efficient lighting solutions, and so forth.
The past decade has seen big changes in the industry, with most
players streamlining operations and transferring more routine
production to low-cost locations. This led to the development of
the Asian market, where most memory production and backend
operations have shifted.
2010 Grew Off a Recession-Dampened 2009
The year 2010 started with a bang, as most companies reported
results that were significantly better than the prior year,
exceeding the companies’ own expectations and blowing past
consensus estimates.
However, most of the excitement started wearing thin by the middle
of the year, as order patterns and customer inventories indicated
slowing demand. Industry watchers contended that the strength in
the first half was more on account of pent-up demand than the
beginning of another growth phase.
With the third quarter results, it was apparent that fears of a
jobless recovery persisted. As a result, consumer spending failed
to pick up in line with normal seasonality and holiday buildups
dropped below expectations.
Net-net, global sales of semiconductor devices came in at $298.3
billion for the year, or a 31.8% increase from 2009, just slightly
short of the Semiconductor Industry Association’s (SIA)
expectations of a 32.8% increase.
The SIA stated that growth was broad-based across all major
categories of semiconductors, which were each up double-digits from
2009. New products and innovations, as well as the broader
application of semiconductors helped this growth. Of course, the
fact that 2009 was weakened by the recession made comparisons
easier in 2010.
Growth was also broad-based across geographies. The SIA estimates
that around 54% of revenue came from the Asia/Pacific region
(excluding Japan), followed by the Americas with an 18% share,
Japan with 15% and Europe the remaining 13%. The Americas grew the
strongest in 2010, followed by Asia/Pacific, Europe and Japan in
that order.
Expectations for 2011 are varied. While the SIA’s projection of
around 6% growth this year was similar to estimates put forward by
iSuppli (5.1%), Gartner (4.6%) and VLSI (4.4%), others, such as IDC
and IC Insights differed widely, with expectations of 9% and 10%
growth for the year, respectively.
Computing and Consumer Markets Biggest Drivers
These two end markets together consume around 60% of total
semiconductors sold. Therefore, they have the ability to
significantly influence total sector performance.
Computing
A number of factors, in combination, are bringing about a complete
turnaround in the computing market. Gone are the days when
component suppliers were limited by a maturing market, worsened by
commoditization and corresponding pricing pressures.
Today, the computing business is being driven by
Microsoft
Corp’s (MSFT) Windows 7 for one. Even with operating
systems, such as
Apple Inc’s (AAPL) Macintosh
platform gaining popularity, and cloud alternatives such as
Google Inc.’s (GOOG) Chrome coming to market,
Windows 7 adoption rates have been high.
Second, Apple’s run of success is a big driver, since the Macintosh
OS runs on Apple devices alone, which means more hardware and
consequently, more semiconductor devices being sold. Third, with
the advent of less sophisticated and ultra mobile devices (netbooks
and tablets), the market continues to expand. Fourth, increased
computerization in emerging markets such as China, India, Brazil
and Russia are also helping growth.
Perhaps the biggest driver of business is the growth in the data
center segment, which has increased focus on servers, storage and
networking equipment that consume semiconductors of the high-end
variety. The cost advantages of moving to the cloud are encouraging
many small and medium-sized businesses, as well as some large
organizations to transfer either a part or the whole of their
operations to the cloud. We expect this change to be a major driver
of growth for the industry in the foreseeable future.
Consumer Electronics
With ultra-portable computing devices gaining popularity, the
distinction between consumer and computing is blurring in some
cases. Of course, the consumer electronics market also includes
other gadgets such as LCD TVs, Blu-ray players and smartphones.
The problem with this segment being a major driver of revenue is
its inherently low margins. Competition is fierce and aggressive
pricing is the rule of the day. Since semiconductors made for
consumer goods are in the nature of components, there is
ever-increasing pressure on their prices that correspondingly
squeeze margins.
The Consumer Electronics Association (CEA) is very upbeat about
solid consumer electronics sales this year. Accordingly, these
products are expected to grow 10% this year on the back of a 13%
increase in 2010 to $964 billion. The CEA believes that strong
demand from the BRIC countries (Brazil, Russia, India and China),
as well as moderate spending in developed countries will drive this
growth. Smartphones, TVs and mobile computing products will be the
hottest products this year.
The CEA’s expectations are reflected in the domestic market.
Consumer confidence in the U.S. economy touched bottom early in the
third quarter of 2010, improving steadily thereafter. However, the
recovery is slow and very gradual, resulting in a muted 2010
holiday season. An offsetting factor noticed by the CEA is
individual buying habits during the holiday season that were
increasingly favoring electronic gadgets, with 3 of the top 5 and 4
of the top 10 most-wished-for items being electronic goods.
Other Markets
Communications infrastructure spending is currently being driven by
China and India. The SIA expects infrastructure spending in these
geographies to remain the major driver of semiconductor sales. The
domestic market will be driven by increasing data volumes.
Medical Devices is an upcoming area and semiconductors targeted at
this market are beginning to do well.
Earlier this year, Gartner estimated that the automotive
semiconductor market would grow 4% in 2011 to $22.707 billion (the
market was up 40% in 2010), as automotive inventory appeared
stable. The research firm also estimated that production of light
vehicles (the primary consumer of semiconductors in the auto
market) would slow down to around 5% this year, after the 19.9%
increase in 2010, marking the first year of sales above
pre-recession levels. Infineon Technologies, Renesas Electronics
and Freescale Semiconductor are the major beneficiaries here.
However, we may see some changes in days to come, since nearly a
fifth of vehicle production has moved to China and we may expect
more to follow. Moreover, semiconductor manufacturers serving this
market have a few advantages. The most important is the growing
electronic content per vehicle, driven by the need for fuel
efficiency, entertainment and automated navigation.
As a result, in normal circumstances, semiconductors serving this
market could have been expected to grow stronger than the industry
over the next few years -- particularly since an automobile model
has a significantly longer life than a consumer device model.
Therefore, once a semiconductor has been designed in, it continues
to generate revenue for a number of years. However, the Japan
crisis will hurt results this year and possibly in the next, as
discussed below (“Recent Developments”).
The aerospace and defense markets are considerably dependent on
government spending and policy making. The commercial aerospace
market (which lags an economic downturn or recovery) has started
looking up, given the increasing passenger and cargo traffic.
The outlook for defense spending on the other hand is not as
bright. Moreover, the focus on terrorist activity remains, so
spending on intelligence systems and basic weaponry is stronger. A
longer-term driver for semiconductor manufacturers is the growing
importance of electronic weaponry. So semiconductor manufacturers
serving these markets continue to see mixed results, depending on
the customers served.
Given the end markets driving the current strength in the industry,
we believe that manufacturers of flash memory (particularly NAND
and also NOR) will continue to see strong demand. The transition
from DDR2 to DDR3 will add to growth in this segment. However, the
crisis in Japan could be a restricting factor on the supply side,
limiting growth.
Ever Smaller & More Powerful
The demand for greater functionality in smaller and more power
efficient gadgets is leading to greater integration within the
semiconductor device. This is leading to increased demand for the
system-on-a-chip (SoC), which is a single device incorporating a
microprocessor, digital signal processor or graphics core, as well
as memory and logic.
Within SoCs, both application-specific integrated circuits (ASICs)
and application specific standard products are expected to do well
(ASICs are usually customized for a single buyer, while ASSPs may
have multiple buyers).
Major Players
The major players in the industry may be categorized into
chipmakers (OEMs-whether fabless or otherwise), equipment and
material suppliers, and foundries.
Chip-makers
According to Gartner Dataquest and iSuppli Corp,
Intel
Corp (INTC), Samsung and Toshiba Corp were the top three
semiconductor suppliers in 2009.
Texas Instruments
(TXN) remained in the fourth position, as the company continued to
phase off its wireless baseband business.
While the two research firms were slightly divided regarding the
order of the next three, both estimated that that they were
STMicroelectronics (STM), Renesas (helped by its
acquisition of NEC) and Hynix.
Micron Technologies
(MU) and
Qualcomm (QCOM) occupied the eighth and
ninth positions. iSuppli allotted the tenth position to Elpida,
while Gartner estimated that it went to
Broadcom
(BRCM). The most disappointing was
Applied Micro
Devices (AMD), which slipped from the eighth position to
number twelve.
Equipment Makers
Gartner estimates that semiconductor equipment sales by the top ten
suppliers increased 2% in 2010, following a 38% decline in 2009,
accounting for 63.4% of total equipment sales. The overall
equipment market is estimated to have increased 143% to around $41
billion in 2010. Automated test equipment (ATE) was the strongest
segment (up 149%), wafer fab equipment (WFE) was close behind with
a growth rate of 145%, while packaging assembly equipment (PAE) was
third, having grown 127%.
The very strong growth may be traced to a particularly weak 2009,
when the recession impacted demand for semiconductors and capital
spending was minimized. In this environment also,
Applied
Materials (AMAT) easily maintained its number one
position, followed by
ASML Holdings N.V. (ASML)
and Tokyo Electron Ltd in that order.
Lam Research
Corp (LRCX),
KLA-Tencor (KLAC) Dainippon,
Teradyne, Inc (TER),
ASM
International (ASMI) Nikon and
Novellus Systems,
Inc. (NVLS) were the others in the top 10.
Foundries
The Foundry segment has undergone significant changes over the past
few years and the top five positions have changed again, according
to research from IC Insights. Although
Taiwan Semiconductor
Manufacturing Company (TSM) remains the leader by far,
followed by Taiwan-based
United Microelectronics
Corp (UMC), GlobalFoundries has now taken the third
position in the pureplay segment, pushing the Chinese foundry
Semiconductor Manufacturing International Corp
(SMI) to the fourth position.
Also, specialty foundry Tower Semiconductor (TSEM) has jumped to
the fifth position. A few clear leaders are emerging in the foundry
segment -- Taiwan Semiconductor at the trailing edge,
GlobalFoundries at the leading edge and Tower Semiconductor in the
specialty category (analog). Additionally, Intel and Texas
Instruments’ foundries make them two strong contenders with leading
edge capabilities.
Recent Developments -- The Japan Crisis
Japan is one of the largest producers and consumers of
semiconductor devices. Therefore, the crisis in Japan has had a
significant impact on the semiconductor industry.
On the production side, there are issues with respect to facility
repair, reliable power supply (which is essential for chip
production) and availability of contingent supplies, which may be
hindered (given the difficulties in transportation following the
disaster and the fact that Japan is accustomed to operating under
the just-in-time model).
Again, facility repair, if it includes fab equipment would not an
easy task, since the equipment is built according to specifications
that could not be replaced easily. This would normally impact
semiconductor supplies. However, what makes it extremely difficult
to gauge the near-term impact is the fact that many large companies
with Japanese operations, such as Texas Instruments, Freescale
Semiconductor and NEC, among others, also have operations in other
regions, to which they could probably move production
temporarily.
The saving grace is that production in Japan was centered on the
automotive industry. A March 24 report from IHS iSuppli stated that
in 2010, Japan produced $11 billion of automotive infotainment
electronics and $7.3 billion of automotive semiconductors, for a
35% and 32% share of the two markets, respectively. Therefore,
other markets, such as communications, industrial, computing and
consumer will see relative smaller impact.
The crisis also has an effect on equipment manufacturers as well.
Given the uncertainties in the supply chain, inventory imbalances
are very likely, which would prompt semiconductor manufacturers to
get conservative about further capex builds. As a result, equipment
manufacturers could see an increased rate of delays, push-outs and
cancellations of bookings over the next few quarters. If there are
no further calamities, they are likely to see improvement some time
in 2012.
OPPORTUNITIES
Manufacturing digital ICs is expensive, as it requires
state-of-the-art technology and processes. On the other hand,
digital products are cheaper, so cost recovery is more difficult.
This has led to specialization in the industry and a greater
contribution from Asian manufacturers. However, a significant
portion of the intellectual property remains with the domestic
companies.
One of the primary beneficiaries of the growth in mobile phones,
tablets and the like is
ARM Holdings (ARMH), with
its power-efficient low-performance chip architecture that
dominates the growing mobile phone and tablet markets. Others would
be Qualcomm, Samsung and Texas Instruments. As such, we remain
relatively positive about these companies in 2011.
We are also optimistic about Intel and AMD, given their focus on
the data center segment. Although we are a wee bit cautious on
Intel’s other growth initiatives and believe that execution will be
key to delivering on its plans with the two big acquisitions, the
company’s market position, cash balance, technology lead and
management strategy and execution are positives in our opinion.
AMD is also worth watching, as management has been delivering on
its promises. Moreover, the company is seeing some real success in
its graphics business, which should complement initiatives targeted
at rationalizing its debt, increasing focus on R&D and
operation of a lower-cost model.
The analog and mixed-signal market is dependent on innovation.
Consequently, these products generate higher margins than digital
products. They are also more customized and have longer life
cycles. These advantages are not lost on U.S. players, so the
number of companies entering the market is on the rise.
Our favorites in this area include Texas Instruments,
Analog Devices (ADI) and
ON
Semiconductor (ONNN). Also, while some companies, such as
Linear Technologies (LLTC),
Semtech
Corp (SMTC),
Intersil Corp (ISIL) and
Maxim Integrated Products (MXIM) will have mixed
performances given their varied dependence on the auto market, they
are, for the most part, highly diversified, high-margin businesses.
We believe these companies will generate moderate growth in 2011,
representing good defensive plays as the cycle peaks.
WEAKNESSES
We believe that the good fortune enjoyed by equipment suppliers in
2010 will not continue in 2011. All the companies here had been
severely impacted by the recession in 2009, as foundries, memory
and logic makers decided to cut capex. This made for easier
comparisons in 2010, so most equipment makers saw triple-digit
growth.
Growth in 2011 was expected to be driven by the memory segment,
which will be impacted by the crisis in Japan. Therefore, results
are likely to come in weaker than earlier projections by SEMI and
Gartner.
We have therefore turned a bit cautious about companies like
Applied Materials, KLA-Tencor and Novellus Systems, as well as test
equipment providers, such as Teradyne and Agilent.
We started the year with a positive feeling about foundries, but
have turned more cautious following the Japan crisis, since they
are likely to feel the impact pretty quickly. In fact Taiwan
Semiconductor was quick to lower its expectations for the year. We
also believe that investors should treat other foundries, such as
United Microelectronics, and Semiconductor Manufacturing
International with caution.
We do not anticipate significant growth in the semiconductor sector
in 2011 given cyclical considerations, although we do not really
see any great weaknesses either. However, we would caution
investors about companies with relatively weak financials, such as
Exar Corp (EXAR) and
FormFactor
(FORM). For instance, FORM continues to burn cash despite stronger
demand for its specialized probe cards. It also has significant
customer and market concentration that increase execution
risks.
APPLD MATLS INC (AMAT): Free Stock Analysis Report
ADV MICRO DEV (AMD): Free Stock Analysis Report
ASM INTL NV (ASMI): Free Stock Analysis Report
ASML HOLDING NV (ASML): Free Stock Analysis Report
INTEL CORP (INTC): Free Stock Analysis Report
KLA-TENCOR CORP (KLAC): Free Stock Analysis Report
LAM RESEARCH (LRCX): Free Stock Analysis Report
NOVELLUS SYS (NVLS): Free Stock Analysis Report
QUALCOMM INC (QCOM): Free Stock Analysis Report
SONY CORP ADR (SNE): Free Stock Analysis Report
STMICROELECTRON (STM): Free Stock Analysis Report
TERADYNE INC (TER): Free Stock Analysis Report
TAIWAN SEMI-ADR (TSM): Free Stock Analysis Report
TEXAS INSTRS (TXN): Free Stock Analysis Report
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