Four of the top 10 companies in our annual Hot Tech Growth 75 are involved in the manufacture of semiconductors. What's behind their banner year?
Companies connected to the chip sector have been among the biggest drivers of technology industry growth in 2007. Four of this year's 10 fastest-growing tech companies manufacture semiconductors or the materials used to make them, according to a ranking of companies with the fastest gains in share price, sales, and profits and the largest returns on equity.
Cypress Semiconductor finished fourth, after Google (GOOG), AT&T (T), and Apple (AAPL), in BusinessWeek.com's annual Hot Tech Growth 75 ranking. Nvidia, MEMC Electronic Materials, and Varian Semiconductor Equipment Associates claimed the sixth, seventh, and eighth spots, respectively.
Pass the Chips, Please
What puts so many chipmakers and their suppliers at the top of the heap? Demand for chips is up, fueled by robust purchases of personal computers and mobile phones. PC shipments are expected to finish the year 13% higher than in 2006, according to researcher Gartner (IT), and consumers are expected to buy as many as 1.1 billion wireless phones, up 13% from the 990 million sold last year, says research firm iSuppli.
Competitive pricing among some of the industry's biggest players, including Intel (INTC), Advanced Micro Devices (AMD), and Texas Instruments (TXN), kept them out of the upper growth ranks.
Instead, some of the biggest beneficiaries are the smaller companies that supply the highly specialized, crucial materials needed to build chips. Consider silicon, one of a chip's most basic components. One of the prime suppliers is MEMC Electronic Materials (WFR), based far from Silicon Valley, in St. Peters, Mo., about a 30-minute drive from St. Louis.
MEMC Rides the Roller Coaster
Spun off from Monsanto (MON) in 1959, MEMC seemed little more than a footnote to the heady boom-and-bust cycles that marked the semiconductor sector in the mid-1990s. As chipmakers such as Intel and Texas Instruments ramped up production to meet the needs of PC and cell-phone makers, they needed more and more of MEMC's silicon wafers, the dinner-plate-size discs from which individual chips are made. As chip manufacturing surged, MEMC's revenues soared, from $552 million 1993 to $1.1 billion in 1996.
The bust came just as suddenly. After overestimating demand, MEMC's fortunes took a nosedive in 1997, and sales fell for six straight years, bottoming out at $687 million in 2002. "The wafer industry was just a train wreck during those years," says analyst Paul Leming of Soleil-Princeton Tech.
Enter Nabeel Gareeb, who, after a 10-year stint at International Rectifier (IRF), joined MEMC as chief executive in 2002 and quickly set about repairing a business model he describes as "badly broken." Gareeb says when he took the job, every dollar MEMC spent on capital expenditures returned only 60¢ in revenue. "We needed gross margins of more than 50% just to break even, and it just wasn't working," he says. Today a dollar spent on cap expenditures at MEMC yields $1.50 in revenue.
The Sun Shines on MEMC
Gareeb's arrival at MEMC was timely: Turns out the polysilicon used in chip wafers also is used in solar panels, which have been in high demand recently, spurred in part by government subsidies in Germany and Japan (BusinessWeek.com, 9/7/06). Demand for silicon is as high now as it's ever been. Spot prices for a kilogram of polysilicon (or simply "poly," as insiders call it) averaged $10 in 2000, but top $200 now.
Gareeb says solar-related business now accounts for nearly 20% of MEMC's sales. On Oct. 25 the company announced a 10-year deal worth more than $7 billion to supply wafers to German solar-power concern Conergy.
Can MEMC keep it up? Analysts expect MEMC to clock north of $1.9 billion in sales this year and to report $3.29 in earnings per share, more than double the $1.60 it reported last year. But Soleil-Princeton's Leming wonders how long Germany can afford to subsidize solar power. "The way Germany has structured it, it has guaranteed pricing in the solar-panel business as far as the eye can see," he says. "But Germany is going to realize that it can't afford this forever."
One Wafer at a Time
Betting on solar power as the demand driver for silicon would have appeared a long shot a decade ago. Another company reaping the benefits of a long-shot bet is Varian Semiconductor (VSEA). Its specialty, ion implant gear, sounds arcane, but it's paying off in a big way, with sales expected to reach $1.1 billion this year, up from $730 million in 2006.
Ion implanting is a crucial step in the chipmaking process. Varian Chief Financial Officer Robert Halliday describes it as "blasting a silicon wafer with a high-pressure spray-paint gun," to implant specific molecules precisely where they're needed. In 2003, when chipmakers typically implanted ions on several wafers at once, Varian made a contrarian wager that it would eventually need to process one wafer at a time. Why? Ion implanting on individual wafers increases the precision with which molecules can be placed, eliminating the unintended damage that can happen when many wafers are processed at once.
Varian's risky maneuver took time to pay off, says analyst Weston Twigg of Pacific Crest Securities. "They came out with this process earlier than their competitors and were able to tune and refine their process," he says. The results speak for themselves: Applied Materials (AMAT), the $9 billion chip manufacturing gear giant, announced in February it was exiting the ion implant business. Since then, Varian's share of the business has soared to north of 60%, up from 43% last year, says Twigg.
Cypress and Nvidia Share in the Sector's Spoils
Cypress Semiconductor (CY)—one of the fast-growing companies that actually makes chips—has certainly profited from the demand for semiconductors, though it owes much of its recent success to an equity stake in solar power concern SunPower (SPWR), which makes and installs solar cells and panels. Cypress also benefits from demand for the Apple iPod: Cypress' Programmable System-on-Chip business is behind the iPod click wheel. The Cypress chip notes how the finger is moving on the click wheel and translates that information into a computer command, such as "more volume" or "next song."
The sixth-fastest-growing tech company is $3 billion graphics chipmaker Nvidia (NVDA). Intel and AMD get much of the credit for pushing the computational power envelope. But the often overlooked yet hugely important components in today's graphics-heavy PCs are the graphics processors from Nvidia and its AMD-owned rival, ATI. Playing games, watching video, and editing photos are all made easier by graphics processors.
Nvidia is the brand of choice among gaming enthusiasts who customize their own machines, but Hewlett-Packard (HPQ), Dell (DELL), and Apple are big Nvidia customers, too. Nvidia's share of the market for graphics chips in notebook computers has grown to north of 80% in the last year, according to analyst Doug Freedman of American Technology Research.
From Laptops to Handhelds
At least part of Nvidia's growth this year can be attributed to stumbles by AMD, which has struggled to integrate ATI and has lost business that Nvidia has been all too happy to take, says Freedman. "ATI couldn't get products out that were very competitive, and that opened the floodgates for Nvidia," he says. Nvidia CEO Jen-Hsun Huang cautions against attributing too much of his company's success to ATI's troubles: "I'd have to ask how much our leadership position actually led to the merger of AMD and ATI," he says. "We were ramping up and became very successful before that merger."
Nvidia's next challenge? Handheld computing. This year it closed a deal to acquire PortalPlayer, the chip company that made its name supplying chips for the iPod. PortalPlayer is a building block in Nvidia's new strategy to attack the handheld computing market. "Eventually all these mobile devices are going to evolve into the first true computer in your hand," Huang says. "We believe they're going to be a lot more common in the next decade."
Check out the BusinessWeek.com slide show for a look at the Hot Tech Growth top 10.