Semis and Semi Equipment Overcapacity Not a Short Term Issue
We have been warning repeatedly that semiconductor makers were ordering too much equipment, a recipe for a capacity glut that is now taking hold, according to this Reuters article:
The utilisation rate of the world’s microchip plants stayed below 90 percent for the second straight quarter in October-December, an industry group said on Wednesday.The utilisation rate was 86.4 percent in the quarter, down from 88.5 percent in July-September and the lowest in seven quarters.
The thing is, the overcapacity is just starting. Orders for new equipment began growing at a faster rate than end demand more than a year ago, and the trend has not reversed. Much of that equipment still has not been installed, and the latest figures suggest things will get even worse.
The article itself hints that this might be the case, but appears afraid to pursue that line of thought to its logical conclusion:
The usage rate remains higher than in previous downturns, amid aggressive production by computer memory makers and ahead of Microsoft Corp.’s (MSFT - Annual Report) launch of its new operating system Windows Vista last month.
The utilisation data was compiled by the Semiconductor International Capacity Statistics (SICAS) group, made up of about 40 major chip makers including Intel Corp. (INTC - Annual Report), Samsung Electronics Co. Ltd. and Texas Instruments Inc. (TXN - Annual Report).
Utilisation rates below 90 percent can discourage chip makers from building new factories, a negative development for suppliers of chip-making equipment like Applied Materials Inc. (AMAT - Annual Report).
SICAS believes things will improve around mid-year. But we saw this week that leading semiconductor makers in both the memory and integrated circuit markets are unwilling to reduce their orders for new equipment, and saw from leading computer manufacturers and distributors that Vista is not providing as large a boost as was anticipated.
We are getting tired of beating this drum, but until the semi makers wise up and trim the pace of capacity growth we have little choice. And the way things are going now, we might have to call auditions for a backup drummer. It looks like our arms are going to get sore before this is over.
Disclosure: William Trent has a long position in SMH.
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[…] Semis and Semi Equipment Overcapacity Not a Short Term Issue […]
Semiconductors have always gone through a boom/bust cycle of oversupply/overdemand.
If you don’t overbuild during the period of oversupply, then you don’t benefit during the period of overdemand.
Is it totally rational? Perhaps not. But unless every semi company got rational at the same time, you’d set your own up for bankruptcy by failing to play nice with the other kids.
Anyway, you’ve also got to keep in mind that you’ve got to order semiconductor equipment at least 6 months to 18 months ahead of when you’re going to get it delivered and add another 6 months to 12 months to get it installed and the problems with your processes resolved. Which means that you’re ordering equipment now in the hopes that you’ll need it two or three years from now.
Anyway, semiconductor companies can’t add new capacity instantly, so they spend their way through most downturns in preparations for the upswings. ’cause it’s always worked before.
Maybe it won’t one of these times. But I think this beating the drum of yours is pretty alarmist. And for someone who’s apparently been an analyst since 1996 seemingly without the benefit of hindsight.
reinharden
It is the semi makers who need some hindsight. I know what has happened to the stocks in every cyclical downturn. The end demand has risen pretty steadily over time - it is the capacity that fluctuates wildly and leads to booms and busts.
If the semi makers consistently invested in 10% growth industry-wide there would be no more cycles and I would no longer have to raise the alarm when they start acting stupid. They would always have on order the equipment they would need just when they start to need it.
But I don’t think I have to worry. They’ll continue to be stupid and I’ll continue to be able to make money trading around their supply issues.
[…] Semis and Semi Equipment Overcapacity Not a Short Term Issue […]
Your premise that “demand has risen pretty steadily over time” only holds true for fairly variable values of “pretty steadily” and neglects entirely the lessons of the last decade.
For example, 2001, 2002, 2003, and 2004 were all smaller years than 2000. Demand fluctuated. Hell, from 2000 to 2001 it cratered.
Granted, over a 10 year perspective, we’ve seen consistent growth decade to decade. But we have seen occasional decreases in demand and we’ve always seen changes in the demand mix.
For example, INTC was the #10 semi company in 1987, but #1 by 1992. AMD was #15 in 2005, but #7 in 2006. AMD could have been higher in 2006; however, they were supply constrained because they didn’t have enough capacity.
The semiconductor market isn’t a seamless whole. For example, if INTC moves to 300 mm platters and 45 nm processes, they’ve just increased their capacity/reduced their cost by a factor of 4. AMD won’t be able to effectively compete with 200 mm platters and 65 nm processes if their cost is 4 times higher.
Not to mention that INTC’s parts will likely go faster at 45 nm *and* use less power which means that they’ll be able to charge premium prices. Or, as they’re doing now (before they even finish the 45 nm migration), charge normal prices and deny AMD the ability to build and equip a new fab without seeking outside financial assistance.
Standing pat doesn’t win success in the semiconductor market. Companies that hop off the treadmill pretty much are destined to long-term obsolescence.
By the by, at least as recently as 2004, many companies considered 85% to 87% utilization as full capacity, 90%+ as supply constrained, and 95%+ as critical shortages. So with utilization only now falling into the historic full capacity range and with most people calling for a bottom this quarter’sh, it only makes sense to bring capacity online now to ensure that it’ll be ready for next year.
I agree that the whole thing is anti-intuitive and in some ways capex spending is a house of cards.
But if you don’t spend and your neighbor does and the demand is there, you’re done. And unless you can spend enough to catch the next cycle, you’re moving several steps down the Top 25 semiconductor list. And in this market, volume is power. So better to overspend and drown you and your neighbors in an oversupply problem than to underspend and let your neighbors thrive in an shortage scenario while you do without.
reinharden
[…] Semis and Semi Equipment Overcapacity Not a Short Term Issue […]
reinharden -
Thanks for your comments. You bring up very important points. So important, in fact, that I wrote a new post to discuss them in greater detail.
[…] We don’t know how they deduce this, nor whether the channel inventories so mentioned will have any bearing on Marvel’s own inventory levels and sales potential. But the mere hint that inventories are being reduced, despite the fact that all signs suggest otherwise, was enough to spark a rally. At least for one night. The author may hold a position in the securities discussed. The author’s current holdings are as follows: Long: Union Pacific (UNP) put options; Air Products (APD) put options; Bookham (BKHM; Ballard Power (BLDP); Syntax Brillian (BRLC); CMGI (CMGI); Genentech (DNA - Annual Report; Ion Media Networks (ION); Three Five Systems (TFS); IShares Japan (EWJ); StreetTracks Gold (GLD); Starbucks (SBUX); U.S. Oil Fund (USO); Plantronics (PLT) call options; Short: Landstar (LSTR - Annual Report) put options; Plantronics (PLT) put options; […]
[…] For all the people who complained about our bearish semiconductor outlook, saying things like “semiconductor companies can’t add new capacity instantly, so they spend their way through most downturns in preparations for the upswings. ’cause it’s always worked before,” perhaps this press release will provide some insight. AMD (AMD - Annual Report) today announced it expects to report revenue of approximately $1.225 billion in the quarter ending March 31, 2007. Revenues declined sharply quarter-over-quarter for the Computing Solutions segment, primarily due to lower overall average selling prices and significantly lower unit sales, especially in the resale channel. […]