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IC
Insights, Inc.

Scottsdale, Arizona USA

www.icinsights.com

©
1998, IC Insights, Inc., Fisher-Holstein, Inc.

August 6, 1998

The
Semiconductor Market Upturn is Close at
Hand

By:

Bill McClean, President, IC Insights, Inc.

Danny Lam, Director, Fisher-Holstein, Inc.

John Kanz, CEO, Fisher-Holstein, Inc.

Introduction

Undoubtedly
1998 will be known as the year of the great semiconductor
bust and it will be compared to the downturn of 1985 when
sales fell 17%. During downturns, industry pundits find it
hard to see an end to the bust, and memories of years of
torrid growth (29% in 1993, 32% in 1994, 42% in 1995) dim as
companies close fabs, lay off people, and ration paper
clips. However, semiconductor industry growth has averaged
17% per year for over 30 years — through two oil crises,
war, recession, the collapse of the Eastern bloc, the
opening of China, and other convulsions.

At some
point, industry growth must slow to more closely match the
rate of growth of electronic equipment sales — which
averaged 10% per year during the past 30 years. But in the
meantime, there is good reason to believe that growth will
return soon. Once again it will catch the naysayers, who do
not believe in this industry’s tendency to let history
repeat itself, by surprise. The purpose of this article is
to: identify and document what we believe to be firm
evidence that an industry upturn has begun and look at how
this upturn is going to play out over the next three
years.

Assumptions

Underlying
our forecast of an upturn in the industry are the following
assumptions for the 1998-2002 timeframe:

  • Japanese
    economy stabilizes in 1999 and begins to recover in
    2000
  • Other
    Asian economies begin to recover in 2000
  • European
    and U.S. economies continue to show steady if
    unspectacular growth
  • Currency
    exchange rates remain at 1998 levels. A sharp drop in the
    Yen to levels like $1=180 Yen would likely spark off a
    competitive round of devaluations which would undermine
    this forecast — and a lot of national
    economies.
  • No
    significant negative impact from the Y2K (year 2000)
    situation such as a halt or collapse of the global
    economy
  • Worldwide
    electronic system growth averages 9 percent from
    1998-2002
  • IC
    feature sizes continue to shrink at historical trends
    through forecast period
  • IC
    ASP increases will be moderate over the forecast period
    due to relatively high levels of capital investment as a
    percent of sales
  • DSP,
    high-end MPU, and ASIC markets all become more
    competitive, increasing pricing pressures in these
    markets
  • Most
    IC producers will wait for 300mm wafer technology before
    they significantly increase capital spending
  • The
    large increase in capital spending forecast for 2001 will
    be partially driven by pent-up demand for 300mm
    wafers
  • Average
    1998-2002 PC unit volume growth of 12 percent

On the
basis of these assumptions, each one of which can
significantly impact the forecast, we are preparing to show
evidence that the long anticipated industry upturn is around
the corner.

Is
The 1996-98 Bust Worst Ever?

There
are as many theories as to the causes of the semiconductor
bust of 1998 as there are pundits. Reasons cited focus on
the great DRAM glut, the Asian flu, and saturation of the PC
market. While these particular factors may account for the
unusual double dip nature of the bust — which has not
happened in the past decade — a bust is entirely
characteristic of the industry. One reason for the
apparently drastic nature of this downturn — compared to
other downturns, is the sky high US dollar along with the
change in the value of currencies of key semiconductor
producing countries. Looking at the Japanese yen as an
example:

Year

US$1=yen

1995

102

1996

109

1997

121

1998

138

Source:
IC Insights data

The
yen, between the peak of the market in 1995 and 1998,
devalued considerably. Because the industry still states its
global revenues in US dollar terms, its appreciation
accentuates any shrinkage in the size and growth rate of
non-US manufacturers, obviously more so of those in
countries with depreciating currencies. The steep plunge of
the won from about the US$1=780 won range to US$1=1,550 won
range within one year had a similar effect of shrinking the
apparent dollar size of their output, holding other things
constant. If we were to restate the industry’s statistics in
a basket of currencies that are more stable, such as ECUs,
it would show an industry performance considerably better
than the present US dollar based numbers indicate and would
provide a more optimistic picture of the
industry.

Other
Exchange Rate Impacts

Another
little-noticed effect is created when the currencies of key
semiconductor producing countries fall quickly; it gives the
industry based there a short term boost in profitability if
the currency exposure is not covered. In particular, Korean
companies which paid for equipment in Won just prior to its
collapse found that they could, over the life of that
equipment, realize a short term one time gain from the
devaluation. Their products are primarily produced for
export and sold for Yen or dollars that are now worth more
Won. This allowed them to cut prices further in dollar terms
and still realize a larger paper profit or a smaller loss,
and generate cash flow in dollars or Yen for their hard
pressed conglomerates.

While
the decline of the Won makes it very difficult for the
Koreans to equip and start offshore fabs, they benefit from
devaluation in the short run. In the medium term, their
competitors will reap the benefits of the Koreans’ inability
to bring their offshore fabs on stream at the right
strategic time, and in the longer term by their need to
invest more expensive dollars or Yen in future upgrades or
expansions — especially costly overseas expansions. In any
case, the Koreans will be less able to subsidize their DRAM
operations in the future, even through the traditional
method, frowned upon by the IMF, of cross subsidies from
other members of the chaebol. This suggests that a major
source of endemic DRAM fab overcapacity will probably work
itself out over the next year or so, removing a big
impediment to healthy industry growth.

Positive
Factors

Taking
a broader look at the fundamentals of the industry by
focusing on the electronic equipment market, we see an
anemic 3% growth rate in 1998 projected to return to around
9%, close to its historic growth rate, for the following
four years (1999-2002). Electronics production is the driver
for semiconductor production, and a return to a normal
growth rate is a positive indicator of industry
health.

Another
view of the industry can be obtained from capital investment
patterns. Semiconductor capital investment is traditionally
cyclical, with a repeated pattern of over and under
expansion. The industry has drastically shifted capital
investment from levels as low as 16.1% of sales in 1987 to a
peak of 32.7% of sales in 1996. It is instructive to note
that the 1996 rate exceeded even that of 1984 (27.4% of
sales) which led directly to the great bust in 1987 capital
spending (16.1% of sales). Thus, the present situation is
entirely consistent with historic industry
patterns.

IC
Insights believes that a steady 21-22% of sales is a
reasonable, sustainable rate of capital investment for
long-term industry growth. However, the industry has never
heeded such norms and has paid the price in drastic boom and
bust cycles. Equipment makers, who are most directly
impacted by such cycles, took the brunt of these wild swings
in demand, limiting their ability to support the
semiconductor industry in an orderly fashion. The drastic
cut in capital spending during the past year or so is
typical of the industry’s overreaction to excess capacity.
Under-investment during the present bust years will, as
before, set up the semiconductor and equipment industry for
the strong upturn by the year 2000.

Additional
Evidence of an Upturn

During
the 2nd quarter of 1998, IC average selling prices (ASPs)
fell to the lowest level since the peak of the market at the
end of 1995. Unit shipments also reversed their decline as
of June, 1998, and have been rising since. DRAM prices, a
critical indicator, have been flat for the past two weeks
— a major shift from the non-stop declines seen during the
past two years. Similarly, prices for microprocessors (MPUs)
have risen recently. PC manufacturers who invested
considerable effort in slimming down their inventories and
switched to build-to-order or build-just-in-time (such as
Dell, IBM and Compaq) have begun to bring these facilities
on stream to meet the anticipated demand for PCs in the Fall
of 1998. The tightly coupled nature of this new supply chain
means that upticks in PC demand no longer have to work their
way through a long inventory tail, but will be apparent much
faster.

As the
chart below shows, cycles in the industry are relatively
consistent and capital spending tracks IC ASPs closely. Once
ASPs begin to show a sustained rise, capital spending
increases follow quickly.


What
About the Upturn?

The
upturn, as with the downturn, will as it did before catch
people by surprise. Historically, IC manufacturers
traditionally either over or under spend on expansion,
leading to wild boom or bust cycles. The extent of this boom
and bust is seen in the following chart:

Year

Growth
Rate Change

80-81

27%
to 5%

82-83

3%
to 26%

84-85

46%
to -17%

85-86

-17%
to 24%

90-91

2%
to 8%

95-96

42%
to -9%

Source:
IC Insights, Inc.

For any
given year, the industry rarely comes within 7% of its
average compounded 20-year historical growth rate of 17% and
is unlikely to do so again during this upturn. Another way
of looking at this is to examine the year-to-year change in
growth rates going into and coming out of a
downturn:

The
industry’s ability to turn from feast to famine in a little
less than a year is a characteristic that has been
demonstrated over and over again. Accordingly, a growth rate
change of from -8% in 1998 to +10% in 1999 is entirely
consistent with industry history. Furthermore, the evidence
indicates that a great semiconductor boom is shaping up for
2000 and 2001, with both years likely to register growth
rates in excess of 24% per year as per the latest IC
Insights forecast.

The
industry’s coming upturn is likely to be entirely in
character with previous booms. The upturn will, however, be
unusual in that it will likely be strong and driven by
several factors, the impacts of which are at present still
difficult to predict precisely. The above forecast by IC
Insights did not factor in the issues below, any one of
which can significantly impact the strength of the
upturn:

Year
2000

We now
know that the Y2K problem has had a depressing effect on
corporate IT budgets and in diverting, to testing, fixing
code, and installing new Y2K compliant systems, resources
that would have gone toward PCs and other IT projects.
However, the upside impact of the Y2K issue has not been
sufficiently researched. On the basis of a pilot study, we
identified numerous examples of electronic equipment that
will have to be replaced prior to (or shortly after) the
onset of the Y2K bug. Much of this equipment is in
facilities like electric power plants, factory control and
automation equipment, and other places that provide
essential services. The equipment, in many cases, contains
embedded processors with non-Y2K-compliant code.

While
we cannot accurately forecast demand that will likely come
from Y2K issues, it is likely that there will be many
“boxes” that are presently working day and night in numerous
locations that will fail. When such equipment fails, rather
than trying to correct the code, the most expedient solution
may be to simply order a new box. The upside impact of this
on demand in 2000 and 2001 will be an issue to watch for as
the Y2K drama unfolds in the next year.

Telecommunications
Markets

During
the next two years, digital wireless technology will, for
the first time, become a major demand driver and open up new
markets. The widespread availability of digital telephones
in North America will likely cause an explosion of demand
for wireless phones and data services. Similarly, the
successful deployment of systems like Iridium and wireless
data services will expand the market for electronic devices
considerably beyond present dimensions. Again, while the
boom from these new services is difficult to forecast, it is
likely that the industry will once again experience an
explosion of growth.

Traditional
Markets

Finally,
it would be wise not to count out the traditional markets
for semiconductors, like PCs, autos, consumer electronics,
etc. All of these will likely be back on their feet once the
current industry slump is over. Indeed, a single killer PC
application can dramatically turn around demand for both
microprocessors and memory. Other one time events like the
GM strike, the distribution snafus caused by Hong Kong’s new
airport, and China’s crackdown on grey market PC imports,
are all passing problems for the industry that are either
resolved or will work itself out over the next few months.
These factors will scarcely retard increased orders in the
second half of 1998. All of these factors point to a
sustained industry upturn in the coming months.

Conclusions

The
industry upturn will, if it goes as before, generate a great
boom that will rapidly soak up the excess capacity that now
dogs the market. Pundits who believe that there are as many
as four or five excess DRAM fabs that should now be closed
may, within a year, be surprised to find insufficient
capacity to meet demand. As demand materializes, there will
be another rush to add capacity. In due course, demand will
outstrip supply, and capacity shortages are likely to appear
by the year 2001, sparking another rush to build. However,
as during previous downturns, the manufacturers who stay the
course during the present downturn will be best able to take
advantage of the upturn. Companies like Intel and IBM will
stand out for having continued to invest during the downturn
and will reap the benefits of existing capacity on line to
meet customer demands, when some competitors will be unable
to do so. History will repeat itself again.




This
article is compiled in part from a detailed 25 page
1998-2002 IC Industry Market Forecast Report
available from IC Insights for $295. Contact

to obtain a copy.

Additional
data and information on industry capacity and trends was
compiled by Fisher-Holstein, Inc. (FHI), a research firm
that specializes in lifecycle cost-of-ownership analysis and
capacity planning of semiconductor wafer fabrication
facilities. Contact
,
for additional
information of FHI products and services.

About
The Authors

Bill
McClean is president of IC Insights, Inc., an IC market
research company that began operations in 1997. Prior to
forming IC Insights, he worked at ICE Corporation for 17
years — the last 10 as vice president of market research.
Mr. McClean serves as contributor and managing editor of
The
McClean Report
,
the company’s annual in-depth survey and forecast of the IC
industry, and
Strategic
Reviews
,
its IC company information database. Mr. McClean received
his Bachelor of Science degree in Marketing and an Associate
degree in Aviation from the University of Illinois. He can
be reached at
.

Danny
Lam is a director of Fisher-Holstein, Inc., a firm that
specializes in lifecycle cost-of-ownership (LCCO) analysis
and capacity planning for semiconductor wafer fabs and the
co-developer of the FHI LCCO decision support system (DSS)
that helps wafer fabs, understand and improve their
lifecycle profitability. His recent publications have
appeared in Semiconductor International (July,
1998), (
www.semiconductor.net/semiconductor/archive/Jul98/docs/feature3.html),
Site Selection Magazine (August, 1998),
Infrastructure (Feb, March, April, 1998), and
Semiconductor Fabtech. (
www.fabtech.org)
Dr. Lam is a fellow of the Economic Development Institute,
Auburn University and a past fellow of the Center for
Science and International Affairs, Harvard University. He
received his Bachelor degree from University of Waterloo, an
MBA from University of Western Ontario, and his PhD from
Carleton University. He can be reached at:

or through Fisher-Holstein, Inc.

John
Kanz, CEO of Fisher-Holstein, Inc., has over thirty-five
years of microelectronics and high-tech industry experience
including hands-on R&D, specialized facility projects,
corporate management, and entrepreneurial startups. With
over fifty technical and academic papers, he also
co-authored a key chapter in the 1996 McGraw-Hill
Handbook of Technology Management and chaired US
and international microelectronics standards groups. He
holds a BS in Physics from the University of Washington, an
MS in Physics from the University of Illinois, and an MBA
and PhD in Management from the Peter Drucker Graduate
Management Center at Claremont. He can be reached at:
¸
.


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© 1998 IC Insights, Inc.