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While 2009 was clearly a down year for the semiconductor industry the stocks have recovered from the bottom set in March 2009. Most of the recovery was driven by  valuation and technical. In 2010, we expect industry fundamentals to improve. The credible indicators that a recovery is on the way include stable memory prices for the past 6 months, lean inventory and component shortage. Managements have indicated that global demand for semi devices have improved and customers are asking for capacity related tools. Bit growth is expected to be in the range of 45-55% in 2010 driven by the adoption of new technologies and products. According to a panel of CIOs at a recent technology conference, 2010 spending will be for “catching up “ on technologies not implemented in 2009 and looking into the future for new ones.

 There are a number of technologies grabbing the attention of device manufacturers, enterprises and consumers. Computing has become an integral part of our every day lives. We can’t leave home without it. Technologies such as virtualization, cloud computing, 3D and solid state drives (SSD), are driving the upgrade cycle in the semi industry. Enterprise spending on SSD has picked up in the past 6 months due to performance and new applications, while DRAM prices have more than tripled in the past 9 months paving the way for profitable growth for device manufacturers.

New equipment will be required to make SSD price competitive not only in the enterprise market but also for penetration into the consumer market. The trend in the semi conductor industry is to put more functionality on a single chip. Therefore, cost and yield improvements are critical for profitability and margin expansion.  It is imperative the semi device makers invest in the next leading edge technology to get a lower cost-per-die. Companies that do not invest will be out of position and their competitive advantage will be compromised and their sustainability questioned.

Currently, only 3-4% of notebooks have SSD. This technology will provide a significant growth opportunity for the industry over the next several years. Initially, the demand for SSD will be driven by the enterprise market due to better performance, reliability, power consumption and speed. In the consumer market-- smart phones, netbooks, notebooks, e-readers will fuel the growth going forward. The consumer has not embraced SSD due to its high price relative to HDD. However, with the advent of cloud computing (application are stored in the cloud, rather than locally) consumers might be willing to trade capacity for performance. Therefore, a price crossover point for SDD and HDD might not be the key factor for SSD adoption in the consumer market.

When SSD penetration accelerates, for long-term investors this could be a multi-year cycle that could change the profitability for many device manufactures.

Oligopoly, Monopoly, Duopoly? February 28, 2010

The computer industry has been riding on the premises of Moore’s Law for the past 20 or more years. Moore’s Law states that the processing power of a chip doubles every 18 months as prices decline by approximately 50%. To put this in perspective, during the 2000-03 downturn average selling prices (ASPs) declined 88% and 2007-08 ASPs declined 77% according to the Gartner Group.  Intel’s latest chip code-named Tukwila has 2 billion transistors and IBM Power7 chip is 4 times faster than the previous version. At this pace of price decline and enhanced capabilities it is very difficult for most chip manufactures to maintain profitability in a silicon cycle. For example, between 2001-2007 the top 8 DRAM manufacturers had operating profits of $10.4B. However, excluding Samsung operating profit was -$1.6B. This means that only one chipmaker was profitable in the DRAM business over a semiconductor cycle.

Therefore, going forward profitability will be the key driver for consolidation and creating an oligopoly. However, consolidation in the industry is not a new phonomomena. Consolidation started when Intel phased out its DRAM business in 1995 and Texas Instruments sold its DRAM business to Micron in 1998. The next phase of consolidation, will create an oligopoly. In memory – Samsung and Toshiba/Sandisk, Logic – Intel and AMD, Networking – CSCO, Huwai and HPQ; Cell phones – AAPL, RIMM and NOK; Hardware- DELL, IBM and HPQ; Software- ORCL, MSFT and SAP; Semi Cap equipment- AMAT, ASML and LRCX; Foundry – TSMC and STMicro. Tier 2 and 3 companies will have to compete with these giants at lower ASPs. The financial powress of these companies give them the ability to make countercyclical investments (i.e. buy leading edge technologies in a downturn), which position them for profitable growth and market share gain in a recovery.

This lack of profitability has also lead to fewer Fabs being built. Only the Tier 1 companies will be able to afford to build new Fabs going forward. In the 1990’s the approximate cost to build a Fab was $2B. Today it cost roughly $4B to build a Fab. Due to this prohibitive cost there are few Fabs being built. According to AMAT’s management there are only 9 Fabs being built between 2010 and 2011. With fewer Fabs being built this means the oligopoly can control capacity and thus prices.

How does a Tier 2 and 3 company compete in this oligopoly world?

First, Tier 2 and 3 companies should focus on strengthening their financial base and embrace new technologies and products. Second, Tier 2 and 3 companies purchasing leading edge technologies should evaluate the total addressable market and geography. The addressable market must be large – at least $3B. These markets include PC, cell phones, video games. TV, set-top boxes etc (see table below). Also, based on the competitive nature and the structure of these markets the companies’ ability to penetrate these markets is very important. Most companies are not profitable in these markets unless they can attain a 15-25% market share penetration. The choice for geographic penetration is also important. For example, the PC industry is very large in the U.S. However, the market is well served and penetrated. Therefore, the incremental buyer is not in the U.S. but rather in China and India due to low market penetration.

Therefore, for technology investors it is imperative that the focus on consolidation not be displaced with the derailment of Moore’s Law because the industry is going through its natural phase of consolidation based on the dynamics and structure of the industry. In the Technology sector the strong becomes stronger and the weak becomes weaker in the absence of large addressable markets and innovation.  This leads to the formation of an oligopoly in various industries that can be very disruptive to others in the food chain.

Written by

Roselia St. Louis