Slowdown Looming in 2007

Jim Feldhan, President, Semico Research Corp., Phoenix -- Semiconductor International, 9/1/2006

With three straight months of decline in Semico 's Inflection Point Indicator (IPI), we are now more convinced than ever that the industry is heading toward a slowdown in 2007. Although the latest IPI reading fell moderately from 15.29 in May to 15.22 in June — a drop of just 0.5% — it capped a three-month trend when the IPI peaked at 16.8. With its forward-looking view of the market, this points to 1Q07 as the start of the next downturn. As a result, Semico continues to forecast nominal growth of 3-4% for the total semiconductor industry next year.

On the surface, there are certain market conditions that seemingly point to strength in the coming year. However, further analysis indicates a different story.

End-use market demand drives semiconductor consumption, and growth continues to occur in a number of markets, which could easily be translated into a strong semiconductor market in 2007. However, the rate of growth of these end-use markets is slowing. As an example, the cell phone market will increase from 912 units in 2006 to 977 units in 2007, a growth of 7.1%. In comparison, this market exhibited unit growth of 14.0% from 2005 to 2006. Thus, while this market continues to show growth, the percentage point growth will be half of what it was the previous year. Furthermore, cell phone unit shipments are forecast to fall 0.6% from 4Q06 to 1Q07. This coincides with the IPI forecast for an overall semiconductor market slowdown occurring in 1Q07.

The good news is that cell phones will continue to consume a large number of semiconductors. The phones will evolve to include more features, including cameras, wireless technology (Bluetooth, Wi-Fi, etc.), music and video. This translates to increased demand for NAND in flash cards, CMOS image sensors for the camera, and other logic to enable the wireless and audio/video functions.

However, as this evolution occurs, remember that growth is slowing in this market, and all this is happening in conjunction with the integration of semiconductor components. For example, in the high-end phones, we can expect to see the DSP integrated into the application processor in the future. This integration trend will serve to counter some of the semiconductor demand caused by additional features.

Desktop computers — another high-volume market — are also expected to show a slowdown in growth from 2006 to 2007. The desktop PC is maturing, and unit growth rates will be in the single digits. Similar to the cell phone market, growth in 1Q07 will be less than in 4Q06; however, in this case, it is because of maturation as well as seasonal demand.

Another market condition that generally signals strength is high capacity utilization and capital expenditures. Recent figures tracking capital expenditures are certainly positive for the market. Capital expenditures will increase 20+% in 2006, which is even higher than our 12.5% forecast in January 2006 that was considered optimistic by some. Capacity utilization rates are high, but are now declining.

But remember, good things never last forever. As a result of high capital expenditures, this new equipment will be put into production during the second half of 2006 and in 2007. This means lower capacity utilization rates for the industry. Along with this comes price reductions.

There are a number of other factors that will also contribute to this slowdown. The economy is at the head of many consumers' concerns, as second-quarter GDP rose at a 2.5% annual rate, compared with the first quarter's annual growth of 5.6%. This is attributed to higher interest rates, increased energy prices, and a sharp decline in the housing market.

Coupled with slowing growth, the inflation gauge showed that core prices jumped at a 2.9% annual rate in the second quarter. This is likely to increase since oil prices have escalated with the indefinite closure of an Alaskan oil field that produces 8% of the daily U.S. crude oil.

Consumers have turned cautious, as consumer spending rose 0.4% in June, compared with a gain of 0.6% in May. Since consumer spending accounts for two-thirds of total economic growth, it's apparent the weak consumer spending figures were a big factor in the slowing of the overall economy.

While all eyes are focused on 2007, we're still looking solid for 2006. Final worldwide revenue shipment data just released by the SIA showed that the total revenue shipments in June were $22.7B, an 18.7% increase from May. Year-over-year, June shipments were 11.9% higher than the $20.3B posted in June 2005.

2006 is on track with our January 2006 unit forecast of 12%. However, the inability of semiconductor manufacturers to hold prices even in a capacity-tight market will result in a revenue growth of ~10%. For 2007, unit growth remains unchanged at 9%, but ASP degradation will produce revenue growth of only 3-4%.