Is the semiconductor industry finally coming back after the long tech recession? Looking at the financial results of the big chip companies, it's easy to get confused. For every Intel Corp., whose third-quarter earnings rose more than 50%, to $1.7 billion, there's a Motorola Inc. In the past quarter, the chip division of the Chicago-based electronics giant suffered a $76 million loss, with sales off by 4%.
In Asia, though, there's little doubt that the chip recovery has arrived. Ask Richard Chang, CEO of Shanghai-based Semiconductor Manufacturing International Corp., a "foundry" that manufactures chips to order for the likes of Infineon, Toshiba, and Fujitsu. After just two years in business, SMIC's two fabrication facilities, or fabs, are running flat out: "Our problem is, we don't have enough capacity," says Chang. So SMIC is bulking up, adding equipment to its factories in Shanghai along with a new plant in Beijing. And in a deal unveiled on Oct. 20, SMIC aims to buy Motorola's biggest Chinese chip plant, a $1 billion facility in Tianjin. If the deal is O.K.'d by China, Motorola is likely to come away with a stake in SMIC and a guaranteed source of chips, say sources in Hong Kong.
The deal mirrors a broader reorganization going on in the chip world. While top-tier chipmakers such as Intel and Texas Instruments have stayed ahead of the pack by plowing billions of dollars into state-of-the-art plants, second-tier chipmakers are struggling. And desperation is driving them into the arms of Asia's flourishing foundries. "It will be a foundry world," says C.D. Tam, a 33-year Motorola veteran who ran the company's Asian operations until he retired in 2002 to become CEO of a Hong Kong science park.
For the biggest foundries, business is on track to match 2000, their best year ever. Taiwan Semiconductor Manufacturing Co., the world's largest foundry, is expected to record revenues of $5.9 billion this year with earnings of $1.3 billion, according to Merrill Lynch & Co. The No. 2 foundry, Taiwan's United Microelectronics Corp., was using less than 50% of its capacity 18 months ago. Today its plants are fully booked. Chronic money-loser Chartered Semiconductor Manufacturing Ltd. of Singapore is seeing an uptick too. And Malaysian foundry Silterra, which struggled since it opened its only fab in 2000, has no spare capacity either. "There has been a rapid turnaround," says Ahmad Pardas Senin, Silterra's executive director.
There's a cyclical element at work here: Rebounding demand in the U.S. for all manner of gadgets -- from DVDs and flat-panel TVs to MP3 players and cell phones -- means bigger orders for the chips that go into them. But there's also a structural shift taking place. For a growing cast of chipmakers, the cost of building a current-generation fab -- as much as $3 billion -- is just too steep. So even long-established chipmakers who barely flirted with outsourcing in the past are going with "fab-light" strategies, farming out significant chunks of production. "We have learned our lesson from the last downturn," explains Loh Kin Wah, who runs Infineon's Asian operations from Singapore. The German chipmaker now wants to triple its outsourcing volume, to at least 30% of its total production.
Thanks to a bit of self-discipline, the foundries are well positioned to meet this growing demand. In the last upturn, too much capacity came on line at once and prices crashed. This time around -- despite a market logic that compels chipmakers to add capacity during downturns so they are prepared when demand comes roaring back -- the Asians didn't overbuild. Jackson Hu, CEO of UMC, says companies learned their lesson during the go-go years of the late 1990s, when top foundries lavished billions of dollars on new 8- and 12-inch wafer fabs.
In the future, all the restraint in the world won't hold up chip prices if China continues its race to build up production capacity. Most of China's big foundries are only a few years old. So they didn't get burned in the last boom-and-bust cycle. Now, they're showing scant caution. In September, SMIC raised $630 million from investors and is planning an initial public offering soon. If China goes for broke, as many analysts expect, the other Asian foundries will face a dilemma. Rapid expansion in China will "[set] the stage for an overcapacity situation in 2005," writes Joanne Itow, an analyst with Semico Research Corp. On the other hand, if the recovery really has legs, the other Asians could wind up regretting that they surrendered business to China.
For now, the Taiwanese are enjoying the prospect of reaping long overdue profits. TSMC doesn't want to lose market share to China, but its founder Morris Chang (no relation to SMIC's Richard Chang) also doesn't want to go overboard. "We aren't going to get into an arms race," he says, adding that TSMC's capital expenditure budget for 2004 won't change much from this year's $1.2 billion. UMC has taken the same stance.
And yet, Taiwanese are shifting some manufacturing to the mainland. TSMC will spend part of next year's budget on a fab in Shanghai, its first in China. And chip industry insiders say that Taiwanese money is behind a fab being built in the eastern Chinese city of Suzhou. Other Taiwanese players are also planning fabs elsewhere.
Sitting in his Shanghai office, SMIC's Richard Chang shrugs off his rival's worries. For one thing, he predicts, some of the announced projects won't get built. Chang also believes that China's internal demand for chips will far outpace the new capacity. China currently makes less than 20% of the chips it consumes, so more plants on the mainland won't upset the global balance.
In any case, from Richard Chang's perspective, oversupply is the last thing people should worry about. Most of the global chip industry has finally come to understand the benefits of outsourcing. If big companies need two fabs, "they will build one and outsource the other," he says. Once they choose that road, he believes, there's no going back.
By Bruce Einhorn in Shanghai, with Adam Aston in New York