Analysts Indicate Turn Is Coming

In the midst of what, by most appearances, is still a hot semiconductor market, leading industry analysts say it's time to prepare for the inevitable: a downturn. What the nine analysts who participated in Semiconductor International's latest mid-year industry forecast webcast debated the most was the timeframe for the slowdown — whether it will occur as soon as 4Q06 or as late as 2008. Much depends on consumer confidence and keeping inventories low. "We have these really high utilization rates but ASPs are not that firm, so we think the industry is still quite skittish, people are reacting more quickly and effectively to inventory changes, which is tempering revenue growth a little bit," said Richard Gordon, managing vice president of semiconductors at Gartner Dataquest (San Jose).

Lower prices on chips despite high-90s fab utilization is a condition the industry has not seen before. This points to a changed market dynamic that may be here to stay with consumers now driving about half of the consumption of ICs. "If you're a retailer, you have to make guesses now as to what the demand will be during the holiday season," said Doug Andrey, principle industry analyst at the Semiconductor Industry Association (San Jose).

The strength of underlying demand for the two largest applications, PCs and cell phones, is of great importance (Fig. 1). "After 2007, as the pop from MP3 and cell phone sales slows, we don't see any new products replacing them that can provide the same kind of growth," said Gary Grandbois, principal analyst at iSuppli (San Jose). "Despite the proliferation of consumer devices, none compares in market size with the size of the PC and cell phone markets," he added. Even so, the replacement cycle for cell phones is in the process of shifting from an average of 24 months to 18 months, and multi-functional phones are becoming more the norm than the exception, fueling growth. Inventory tracking through 1Q06 (Fig. 2) indicates the industry is in the normal range.

1. This year, unit shipments of PCs are expected to increase by 10-12%, while shipments of cell phones are expected to go up by 20%. (Sources: Semico/Gartner/IDC/Strategy Analytics/SIA Forecast)

Jim Feldhan, president of Semico Research (Scottsdale, Ariz.), pointed to a strong second half of 2006, with overall semiconductor growth expected to come in at ~12%. However, he said that factors such as rising oil prices, rising interest rates, high debt in the United States, and high capital expenditures may indicate a slowdown in the market beginning in early 2007. "The Semico IPI took a significant drop in the April timeframe, which points to a change beginning in January 2007," Feldhan said. The company's long-term semiconductor forecast is optimistic (Fig. 3).

Only one analyst went on record to say that the industry has an existing overcapacity situation. "There is obvious overheating in the industry," said Bill McClean of IC Insights (Scottsdale, Ariz.). He points to the high unit growth rate in 2006, projected at 15-16%, which is comparable with 2001 and 2004 levels — levels that quickly proved unsustainable and led to downturns. He added that there has been double ordering at TSMC and other companies.

2. The Dataquest Semiconductor Inventory Index increased in 1Q06 to 1.08. Low inventory levels may lead to increased production to build inventories in anticipation of demand. If demand does not materialize, inventories could rise like in 2004. (Source: Gartner Dataquest)

Dan Tracy of SEMI (San Jose) commented that based on a survey of semiconductor equipment and materials suppliers conducted just prior to the SEMICON West show in July, stronger capital spending in 2006 will lead to reduced spending in 2007. "We originally forecast a 9% increase in equipment growth for 2006, and it now appears that it will be closer to 20%; so to some extent, capital is being pulled out of 2007 into 2006," he said. SEMI is expecting a flat year in semiconductor equipment sales for 2007, with resumed spending in 2008.

3. The forecast calls for continued revenue and unit growth, with the market exceeding $300B in 2007. (Source: Semico Research Corp.)

"We see good behavior by the industry, with not too much added capacity versus the underlying demand," said Moshe Handelsman, president and founder of Advanced Forecasting (Saratoga, Calif.). "But after four years of going up, and bookings ramping faster, we may close the gap with underlying demand. We look for an increase in ASPs because when the industry is not overheated, ASPs are stable and low."

One remarkable result of the industry's reliance on consumer spending is the decreased margins associated with the semiconductor business. This has made companies more cautious than ever, which could actually help dampen the severity of the cycles in years to come. "In the consumer environment, profitability is not what it once was. Companies have to decide how much profitability they are willing to sacrifice for market share. The markets are fractured and price sensitive, and there's a $200 price-point associated with consumer goods," said Carl Johnson, executive director of research at Infrastructure (Carrollton, Texas). Feldhan added that just such a phenomena was responsible for a drop in ASPs in the first quarter of 2006. At that time, Apple's orders for NAND flash memory in iPod products exceeded demand, so prices dropped dramatically, but then stabilized by April 2006. "Companies that want to grow their market share are willing to be flexible on price. NAND flash has proven to be a very elastic market," Feldhan added.

"The wild card is NAND flash/DRAM interplay," said Gordon. He added that NAND flash is truly a seasonal market, peaking during the holiday season and slowing during summer months. Recent talk of a delay in the release of the latest iPod Nano product will no doubt impact the market. "It's very difficult to predict the impact NAND growth will have. And, the cyclicality we will see in the future may be very different than in the past, which makes forecasting difficult," he said.

All analysts agreed that the sheer variety of semiconductor products today makes the market more difficult to analyze. "These are interesting times," Johnson said. "Device manufacturers are wondering if they will get ROI on their capital; they feel pressures on their energy consumption; and there are supply issues for some materials, which could put a damper on 2007."

Feldhan commented on the industry's readiness for 65 nm. "The move to 65 nm is going to be a little less painful than the move to 90 nm. There are a lot of shells ready for equipment, and the industry is better able to react to changes in demand than it has been in the past."

New fab activity is truly global. McClean pointed out that most device manufacturers tend to build new fabs where they have existing facilities, such as Texas Instruments in Dallas and AMD in Dresden, Germany. Tracy added that of the 19 new 300 mm fabs in the equipping or ramping stages, the greatest concentration is in Asia, but there are still six in North America. Johnson said that the used equipment business is alive and well, with some fabs upgrading incrementally from 6 in. lines to 8 in. lines.

Overall, the analysts agree that the semiconductor market has slowed to a long-term growth rate in the 8-10% range (Fig. 4). It is the short-term changes that are so hard to predict. "One thing companies are not good at is forecasting consumer behavior. If the consumer decides to stop buying, that could cause a decline for the industry," said Steve Szirom, president of InsideChips.com (Bellingham, Wash.). But for now, most remain optimistic that inventories are being controlled and demand remains strong.

4. Despite the year-over-year volatility, the industry has enjoyed four years of continued revenue growth. (Source: SIA)