Chipmaking Titans Under Seige?

Upstarts and giants alike are taking on global leaders TSMC and UMC

Richard Chang, chief executive of Shanghai-based Semiconductor Manufacturing International Corp. (SMI ), is quietly discussing chipmaking when an assistant calls him away. After 10 minutes, the head of China's leading chip foundry returns, appearing shaken. Chang says the Taiwanese government has just sent a fax accusing him of violating Taipei's investment rules in China -- and is threatening a $750,000 fine and a two-year jail term. The 56-year-old Chang, who grew up in Taiwan but is now an American citizen, denies any wrongdoing. The summons, he says, is simply designed to scare his customers. "They're just trying to harass us," he fumes. "They don't want to see China have a semiconductor business."

Look no further for evidence that a brutal chipmaking war is heating up in Asia just as the highly volatile industry is peaking. While Taipei officials wouldn't comment on Chang's summons, there's little doubt that Taiwan wants to beat back any challenge to the dominance of its foundries, which make semiconductors for other companies. For years, two Taiwanese giants -- Taiwan Semiconductor Manufacturing Co. (TSMC) (TSM ) and United Microelectronics Corp. (UMC) (UMC ) -- have been the world's top chip foundries, with a combined 70% of the market. And business is booming. TSMC reported profits of $1.4 billion on sales of $6 billion last year, while UMC earned $418 million on sales of $2.5 billion. Analysts expect big increases this year, too.

But that's only part of the picture. Investors, worried that the chip cycle has peaked and that another recession will hit the industry next year, have punished shares of both companies. TSMC's Taipei-listed stock is down 18% since January, while UMC is off 19%, vs. a 9% fall in Taipei's Taiex electronics index. And as the companies start making semiconductors with circuits smaller than 90 nanometers -- or 90 billionths of a meter -- the technical challenges are growing. "The foundries are going to encounter major hurdles," says Bhavin Shah, an analyst at J.P. Morgan Securities (JPM ) (Asia Pacific) in Hong Kong.


Investors are equally concerned about the competition bubbling up from smaller rivals. IBM and Fujitsu have moved aggressively into the foundry business and may peel away some high-end customers. Chang's SMIC is building next-generation production lines in Beijing and in October bought Motorola's Chinese chipmaking operation. And Chinese foundries such as Grace Semiconductor and Shanghai Hua Hong NEC Electronics are going strong. Combined sales at the five biggest Chinese chipmakers soared to $725 million last year, from just $182 million in 2002. "Chinese manufacturers finally have achieved global recognition and now are a major contributor to worldwide semiconductor supply," says Len Jelinek, an analyst with researcher iSuppli Corp.

The two Taiwanese chip titans are steeling themselves for the fight. TSMC recently won approval from the Taiwanese government to operate its first factory in China, located on the outskirts of Shanghai. The company has also brought charges in a U.S. Federal Court against SMIC, alleging theft of its trade secrets, although SMIC denies the charge.

The Taiwanese also are boosting their cooperation with chip designers, chip packagers, and others up and down the food chain -- something the Chinese upstarts aren't able to match because their technology still lags behind the Taiwanese. "We have to work with all the players much more closely than ever before," says UMC CEO Jackson Hu. At the same time, TSMC and UMC are trying to stop customers from straying by keeping a lid on prices despite booming demand. "We don't give customers unpleasant surprises," says TSMC Chairman Morris Chang.

The Taiwanese, though, are being cautious in their battle plans. The $2 billion that TSMC is spending on expansion this year makes up about 25% of sales, down from nearly 80% the last time the business peaked, in 1999-2000. That wariness may help them better endure any downturn. And as the chip wars heat up, a helping hand from the Taiwanese government won't hurt, either.

By Bruce Einhorn in Shanghai, with Tim Culpan in Taipei

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