Chipmaking's New Capital: Asia

Demand is now strongest in the region, and S&P thinks China has the greatest potential for semiconductor producers

By Richard Tortoriello

Another shift in economic power from West to East is quietly taking place. But this time, it doesn't involve oil or automobiles but tiny squares of silicon and metal known as semiconductors. According to the Semiconductor Industry Assn., the boom year of 2000 marked the end of U.S. dominance in this market, with the Americas accounting for 31.3% of worldwide chip sales vs. 25.1% in the Asia/Pacific region, 22.9% in Japan, and 20.7% in Europe.

Only a year later, Asia/Pacific had jumped into the lead, with a 28.7% share, compared to 25.7% for the Americas. And Asia/Pacific is the only region expected to grow in 2002.

A couple of factors have been driving this shift. One is the emergence of semiconductor contract manufacturing. With plants costing up to $2.5 billion, many chipmakers have opted to outsource all or a portion of their production. At the center of this contract-manufacturing industry is Taiwan, followed by other Asian countries such as Singapore, South Korea, Malaysia, and China.


  Another factor in Asia's increasing chip dominance is the region's domestic demand, as expanding economies require more electronics goods and infrastructure, and consumers experience increased prosperity. Among the fastest growing of these economies and clearly the one with the most potential is China (see BW Online, 9/23/02,"China's Fabless Appeal").

Sales of cell phones, PCs, chips, and software in China have all been climbing at double-digit rates in recent years. At the same time, the Chinese government has sponsored an aggressive plan to build new chipmaking and packaging plants and semiconductor-design houses. Despite the success of this plan -- China already has 10 major chip manufacturers and about 100 design houses -- the country's semiconductor production now accounts for only about 20% of domestic demand. The rest is still imported.

In addition to its fast-growing market, China offers foreign chipmakers cost advantages, including substantial tax and land-price breaks, as well as a plentiful pool of skilled workers and cheap wages, water, and utilities. Construction costs are estimated to be 35% less in China than in Taiwan, bulk gas is 30% cheaper, and the water supply is 60% less expensive. These factors have spurred a flood of foreign investment in chipmaking in the country.


  Motorola (MOT ) has become the largest U.S.-based investor in China. It has spent over $3.4 billion there to date and plans to invest over $6 billion more by 2006 to establish a manufacturing and research-and-development base. Motorola is targeting high-growth markets, including semiconductors, broadband communications, and digital trunking systems (used in wireless communications), and it aims to reach $10 billion in annual production by 2006.

Texas Instruments (TXN ) is another early entrant in the Chinese market. It led competitors with sales of broadband and wireless-systems chips in China. Recently, TI announced an agreement with China's Semiconductor Manufacturing International Corp. that gives the Chinese outfit TI's first chipmaking base in China. To get around U.S. export restrictions, TI will manufacture the "critical" layers of the chips in the U.S. and then ship the wafers to China for manufacture of "noncritical" (or metal interconnect) layers.

Applied Materials (AMAT ), the world's largest maker of semiconductor equipment, recognized early the country's potential and opened its first office there in 1984. Applied projects that sales to China will rise from 2000's $100 million, or 1% of revenues, to over 5% of sales by 2005, or a projected $1 billion.


  Chinese semiconductor manufacturing isn't likely to take over the world anytime soon -- it accounted for just 2% of semiconductor unit volume sold worldwide in 2001. However, with its urban population of over 400 million people, rapid economic growth, increasing investment in chipmaking, and burgeoning electronics markets, investors should take note of China's long-term growth potential.

Businesses that are building strong positions in China now -- such as Motorola, TI, and Applied Materials -- are likely to be the ones to reap large benefits from this growing market in the future. For the near term, however, Standard & Poor's has a 3-STARS (hold) ranking on shares of Motorola and TI and a 2-STARS (avoid) ranking on Applied Materials.

Analyst Tortoriello follows semiconductor equipment stocks for Standard & Poor's

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