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 guidance 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 were not off the mark. 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 the Asia/Pacific, Europe and Japan
in that order.
So Far in 2011
Expectations for 2011 are close to the SIA’s projection of around
5.4% growth this year. Specifically, estimates put forward by
iSuppli (7.2%), Gartner (5.1%) and VLSI (4.4%) have not changed
much, while others, such as IDC and IC Insights. significantly
lowered expectations from 9% and 10%, respectively, to 1% and 5%,
respectively.
The SIA stated that the industry grew modestly in the first half
(up 3.7%), naming the corporate refresh cycle, smartphone growth,
increased spending on It infrastructure as the main drivers that
were partially offset by cautious consumer spending and the
disaster in Japan. Increased use of semiconductors in all end
markets and particularly in the automotive market will drive
semiconductor sales, according to the SIA.
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. Although developed markets
continue to show signs of maturing, worsened by commoditization and
corresponding pricing pressures, there are some points of
encouragement as well.
Microsoft Corp’s (MSFT) Windows 7 continues to
drive sales at enterprise customers, while Windows 8 is expected to
launch with important changes that could speed up adoption of
mobile devices. 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 held up
relatively well.
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 is emerging as one of the strongest drivers of growth in
this market.
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.
The main negative for the computing market is the cannibalization
by tablets, which are in the nature of consumer devices with
computing functions. This is pulling down spending on core
computing (PCs, notebooks and netbooks).
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, it sees
shipment revenue increasing 5.6% from 2010 to $190 billion
(assuming a GDP growth rate of 2.4%), an improvement over its prior
expectations of a 3.5% increase in shipment revenue. Shipments are
expected to grow to an all-time high of $197 billion in 2012. The
CEA believes that smartphone sales will grow 45% this year,
representing the most significant driver of consumer electronics
sales in 2011.
E-reader sales are expected to double, reaching 16.5 million in
shipment volumes and $1.8 billion in revenue. Tablets are expected
to grow far more than initial expectations, with a number of new
vendors entering the market. The expectation for the TV market is
mixed. Since penetration of digital TVs is quite high (88%) in the
U.S., the CEA expects a modest decline this year. However,
network-enabled and 3D TVs are expected to grow (expectations for
3D TV are up from 1.9 million units to 3.6 million units). Digital
cameras are expected to grow 3%.
The CEA’ 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. The trend may be
expected to continue, which is a positive for semiconductors
serving the market.
Other Markets
Communications infrastructure spending continues to be driven by
buildouts in 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 adoption of semiconductors
in this market may be expected to accelerate over time.
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 should grow stronger than the industry over the next few
years. Particularly so, 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. While the Japan crisis will hurt
results this year, it appears that the impact will be much less
than expected earlier.
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) continues to
strengthen, as passenger and cargo traffic continue to
increase.
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 be stronger than other segments in 2011. The
transition from DDR2 to DDR3 will add to growth. However, the
crisis in Japan is likely to serve as an offsetting factor.
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 2010.
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.
Impact of Japan Crisis on 2011
Japan is one of the largest producers and consumers of
semiconductor devices. Therefore, the earthquake and tsunami in
Japan has had a significant impact on the semiconductor
industry.
On the production side, there were 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 be an easy task, since the equipment is built
according to specifications that could not be replaced easily. This
would normally impact semiconductor supplies. However, 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 moved production temporarily.
Additionally, 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 would
see a relatively smaller impact.
Although the crisis was very well managed to minimize disruptions,
there were inventory imbalances that made semiconductor
manufacturers more conservative about further capex builds. As a
result, equipment manufacturers continue to see an increased rate
of delays, push-outs and cancellations of bookings.
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, 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 computing market
performance falls below expectations.
WEAKNESSES
We believe that the good fortune enjoyed by equipment suppliers in
2010 will not be sustained 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 was first impacted by the crisis in Japan and then by slowing
demand for computing devices and sagging consumer confidence.
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 and ebbing
consumer confidence. The weakness in the PC market has made matters
worse. In fact Taiwan Semiconductor was quick to lower its
expectations immediately after the Japan quake. We also continue to
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 the mid-cycle correction, 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 the
strong demand for its specialized probe cards. It also has
significant customer and market concentration that increase
execution risks.
APPLE INC (AAPL): Free Stock Analysis Report
APPLD MATLS INC (AMAT): Free Stock Analysis Report
ASM INTL NV (ASMI): Free Stock Analysis Report
ASML HOLDING NV (ASML): Free Stock Analysis Report
GOOGLE INC-CL A (GOOG): 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
MICROSOFT CORP (MSFT): Free Stock Analysis Report
NOVELLUS SYS (NVLS): Free Stock Analysis Report
TERADYNE INC (TER): Free Stock Analysis Report
TAIWAN SEMI-ADR (TSM): Free Stock Analysis Report
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