(INTC) Semiconductor Industry Trying to Survive

July 30th, 2009

Tony Daltorio, The Investment U Research Team

The financial downturn and global recession has hit the semiconductor industry hard.

Orders for microchips were almost non-existent at the end of 2008 as computers and mobile phones languished unsold on retailers’ shelves.

According to the Semiconductor Industry Association, global semiconductor sales fell 2.8 percent last year and are expected to fall a further 21.5 percent to $195.6 billion this year.

Despite the positive reaction in the stock market to the latest sales figures from Intel (INTC),the world’s biggest chipmaker, the numbers were mixed at best. Intel did enjoy a sales revival driven by consumers buying cheaper, smaller netbooks, but revenues fell in Europe and sales in the key business customer area were weak.

Let’s take a closer look at the semiconductor industry for profit opportunities.

This Time It Is Different

The semiconductor industry is used to severe cycles in their business. It has seen six significant cycles since the 1970s, caused by recessions and oversupply. The last, when the dotcom bubble burst in 2001, saw sales plunge 45 percent.

But this time, it’s different. Strategic issues, such as soaring development costs and the intensifying need to innovate, have combined with the effects of the global recession and are unleashing forces that will reshape the entire industry.

One of the traditional driving forces of the semiconductor industry – computer sales – has been slowing over the past several years. Shipments of computers in 2009are estimated to decline once again, by 6 percent. This decline in computer sales is forcing chip companies to look elsewhere for growth.

So now Intel and other chip firms are eyeing the mobile, netbook and video game markets as areas for growth. The industry as a whole is also looking to embedding chips into a range of devices including TV sets, refrigerators,blood pressure monitors - any device that could benefit from being connected to the Internet.

A Difficult Transition

A switch to these other applications for the chipmakers will not be easy; the market for mobile chips is already highly competitive. The type of chips required for other applications are much smaller and more power-efficient than those used in computers.

As chips become smaller and smaller, development and production costs soar. The tools to make such tiny chips are too expensive for companies to recover their costs over the lifetime of production. Intel estimates that only companies with about $9 billion in annual revenues can afford to be in the business of building new fabs. That would leave only Intel, Samsung, Toshina (Toshiba?), Texas Instruments, and STMicroelectronics.

The high development cost of new, smaller chips is thinning the “herd” of chip companies. Many companies have closed their manufacturing facilities and have outsourced manufacturing to Asian foundries. The fourteen chipmakers that were in the game at 90 nanometer have been reduced to nine at the current 45 nanometer level. Only two – Intel and Samsung – have firm plans for 22 nanometer factories.

Many chip companies have turned their focus to specialty chips in an attempt to survive – radio receivers, power controls, sensors – where shrinking sizes are not the key driver.

The very largest chip companies may also need to experiment with new materials and work at the nanoscale – manipulating chips at the atomic level – in order to survive.

President of the Semiconductor Industry Association, George Scalise, said “We are now facing the research dilemma. Will the semiconductor industry lead the transition to the era of nanotechnology – or will we go the way of the vacuum tube manufacturers?”

None of the companies that made vacuum tubes for the first computers in the 1940s and 1950s survived the switch to the silicon age. It is a sobering thought for both the companies and investors in the sector.

Semiconductor Winners

Investing long-term in the technology industry is difficult because the technology can change so rapidly. Today’s winners become tomorrow’s losers. Therefore, any broad-based investment, such as an ETF, should be avoided. Investors should stick to a large player such as Intel, or specialized chip companies.

We’ll now take a very brief look at two possible winners besides Intel in the semiconductor industry:

STMicroelectronics (STM) – One of the best-loved features of both the iPhone and the controllers of the Nintendo Wii games console is that they react to being shaken, moved and turned upside down. STMicroelectronics accelerometer chips make this possible.

This division of STMicroelectronics is still small relative to the company’s total business, but it is growing rapidly. The company has shipped 500 million accelerometers in the last four years and this business has remained resistant to the downturn.

According to the research company iSuppli, about a third of all mobile phones could be using accelerometers by 2010, with overall revenues for the chips reaching $1.6 billion by 2013. This is a growing niche chips business: Nokia, Samsung and LG are all starting to use accelerometers.

STMIcroelectronics has said that accelerometers “are the kind of revolution as the mouse was for computers in the 1980s” and should prove to be profitable for the company.

ARM Holdings (ARMH) – This company looks set to battle Intel for the future of the microprocessor. ARM Holdings dominates the market for mobile phone chips, with about 95 percent of handsets containing microprocessors designed by the company. Its designs form the basis of chips made by companies such as Qualcomm, Texas Instruments and STMicroelectronics.

The company’s chips are about a quarter of the size and power consumption of Intel’s Atom chip, but the Atom chip is twice as fast. The differences between these chipsare expected to shrink, leaving the advantage to be determined by the alliances that the two companies form.

ARM Holdings recently scored a coup as Google announced their new Chrome operating system would run on ARM-designed semiconductors. Other software companies, such as Adobe Systems, have also begun to switch their software to run on ARM chips. Microsoft, however, has yet to do so.

The bottom line: investors should approach the semiconductor industry with caution, and look for profitable niches.

Good Investing,

Tony Daltorio

View original at: Investment Advice and Investment Research with a Contrarian Point of View