InsideChips.Ventures ( October 2001)
Semiconductor Business Oultook
Are We at the Bottom Yet?
This is the question reverberating through the analyst community
and trade press, and among companies. The concomitant follow-up question is, of
course, If not, when?
During my three decades in the chip industry, I have been
through several business cycles - some more brutal than others. I have thought
long and hard about the current situation and, drawing on my past experience,
believe history provides significant insight into how it will play itself out.
Business Cycle Position
In most of 1999 and 2000, chipmakers were selling virtually
everything they could squeeze out of their factories. Because of the unending
optimism on the dot-com front, the Nortels and Ciscos of the industry were
increasing their capacity for what seemed like an infinitely expanding computer
and telecom market. The Internet infrastructure market was surpassing the PC
market's long-established position as the driver for the chip industry.
Semiconductor valuations went through the roof, especially for
network/communications stocks (for example, Broadcom and AMCC) and IP firms
(such as Rambus and ARM). But the sky-high valuations, driven in part by the
Internet craze, reached levels that were unsustainable. Like a runaway freight
train, the current downturn came suddenly and caught everyone in the chip
industry off guard.
The dot-com bust came quickly and mercilessly, and those
companies' lavish spending habits ground to a halt. Semiconductor producers,
which had ramped their capacity to the max, had to step on the brakes hard. At
first, there was a slight hesitation as year 2000 ended; by the end of the next
quarter, however, it was clear this was not just a moderate correction. Many
executives wishfully talked up a rebound, trying in vain to keep the slump
relatively short and encourage a bounce-back in the second or third quarter this
Unfortunately, the industry is still in the waning phase of the
business cycle, and visibility is poor.
The data for long-term monthly semiconductors shipments are
shown in Figure 1 on page 3. The latest downward correction began in the fall of
2000; after reaching an $18-billion monthly shipment rate, the shipments have
dropped to about $10 billion per month - with no evidence of a bottom forming as
of July 2001.
Excess inventory is being whittled down, but a glut still
encumbers the industry. Fabrication facilities are operating at substantially
decreased utilization rates, estimated at 50% to 60% of total capacity. In
addition, the general economy is slowing and, given the rising unemployment
rate, its outlook is uncertain. As a result, consumer electronics will not be as
robust as in past years. PCs, which are still a large discretionary purchase for
consumers, are showing quarter-to-quarter weakness. One research firm, IDC,
expects sales to be down about 10% worldwide this year.
The grim state of affairs brings to mind other downturns I've
witnessed in the chip industry, the most severe being the 1975-76 bloodbath that
reduced logic ICs to ridiculously low price levels. Texas Instruments dominated
the logic IC market at the time and it went after market share; many logic
providers, such as Fairchild Semiconductor, Motorola and Signetics, were
bloodied. At the time, I worked for Motorola at its operations in Toulouse,
France. I distinctly remember the gloom-and-doom communiqu鳠coming by telex
from headquarters in Phoenix. My associates were telling stories of the company
shutting down entire wings (will the last one to leave please turn out the
lights...). Rumors circulated that the Motorola's chip operations would be sold.
Interestingly, I have heard the same rumors circulating today
regarding Motorola selling its chip business, which is undergoing a retrenching
just as severe as the one 25 years ago. Motorola has cut approximately 35,000
jobs since last December, leaving a workforce of about 110,000.
I do not believe we have reached the bottom yet. The current
downturn, when viewed in the historical context of previous slumps, appears to
be several quarters away from a rebound. Although there is some anecdotal
evidence the downward spiral is stabilizing, there are no hard data indicating
an immediate turnaround.
Industry Reaction to the Downturn
One characteristic of this downturn is that high-tech companies
reacted more swiftly than in the past. This reflects better real-time inventory
monitoring and sales-channel feedback.
Another interesting trend found in the current cycle is the
tremendous amount of positive spin given to layoffs. I thought the term
"downsizing" in the last slow period (1997/98) was a nice euphemism for
laying off employees. This time, many firms' term of choice is
"rightsizing". Other companies have called it "strategic refocusing"
and one of my favorites - establishing a "performance improvement plan."
Whatever it is called, U.S. chipmakers have reacted to the downturn by
initiating wave after wave of slash-and-cut headcount reductions.
Rightsizing in Europe (Europeans call their layoffs
"redundancies") is more difficult than in the U.S. In most European
countries, the local employment laws make it very difficult to lay off workers.
This is one of the factors causing higher unemployment rates in Europe, as
companies take a very cautious approach to hiring new workers; they tend not to
staff to the hilt during boom times because the same staff will be with them
during the downturn.
The European market typically slows after a downturn in the U.S.
is already well entrenched. Europeans are returning from their summer vacations
to a weakened chip industry.
Japan's companies, which have traditionally provided lifetime
employment for their workers, are moving away from that long-established
employment strategy and beginning to focus more on results-oriented management
styles. One trend in alignment with that new mode of operating is large Japanese
corporate conglomerates breaking out their semiconductor divisions. Still,
change is more evolutionary than revolutionary in Japan, and employment
reduction is accomplished today using various "early retirement" schemes.
Japan has been undergoing a severe industry slowdown and is on
the verge of a recession. The Nikkei stock average is now hovering around
10,000 - representing a 17-year low. The country's turmoil is seeping across
its borders and affecting Taiwanese chipmakers, many of which are in various
stages of implementing co-development and outsourcing deals with Japanese
No one can predict the future of the chip industry and
definitively answer the two questions posed at the beginning of this piece:
"Are we at the bottom yet?" and "If not, when?"
However, I make the following assertions with great confidence:
1) The chip industry is real and is very unlike the dot-coms,
which sprang up rapidly and bombed with equal intensity. Chips are the crude oil
that fuel the electronics industry and the Internet age. They have had, and will
continue to have, a profound impact on the world. My comments also apply to
equipment and materials suppliers, as well as those in the EDA business. The
semiconductor industry is not a fad and will not go away. While that sounds
obvious, I point it out because high-tech has been closely associated with the
Internet dot-com boom, which was little more than an investment craze built
largely on smoke and mirrors. Consumers went for it lock, stock and barrel
because they could easily understand the benefits. The average consumer does not
have the same understanding of the semiconductor industry, even with Intel's
widely recognized marketing campaigns.
2) The semiconductor business cycle is not dead. Back in 1999
and early 2000, some very smart industry spokespersons proclaimed that the
business cycle is no longer as relevant to the industry as it was in the past.
However, as long as there is overbuilding of capacity; as long as there are
technologies that explode on the market like the Internet; as long as commodity
chips are priced like airplane seats - there will be a business cycle.
To summarize, not only did the dot-com craze experience a
spectacular wipeout, but our own chip industry became impacted by four
1) A decline in IT spending that has caused the network sector
(which was increasingly becoming the driving force in the chip industry) to
2) A slowdown in wireless deployment and cell-phone sales, which
has caused wireless-oriented companies to retrench.
3) A slowdown in the PC industry, which still plays a
significant role in determining the chip industry's total revenues.
4) An oversupply of wafer capacity, due in large part to fabs
established in the late 1990s coming on line and putting downward pressure on
At InsideChips, we watch the semiconductor indexes
closely. One of the more popular indexes, The Philadelphia Semiconductor Stock
Index (SOX.X), depicts the action of stock prices between 1994 and the present.
During this time period, investors have experienced three intermediate
upward-moving peaks: fall 1995, fall 1997, and spring 2000. The dotted lines in
Figure 2 (page 3) trace the index's upper and lower ranges and clearly show
the long-term upward trajectory of the industry. Our own analysis was pointing
to the industry bottoming out at the 400 level in the index for sometime around
January 2002. That would have been a 3:1 contraction in the index - consistent
with other recessions.
Then, the tragic events of Sept. 11 sent a shock wave throughout
the world. The financial world came to a standstill as the nation mourned the
needless loss of human life. As a consequence, we are revising our outlook to
reflect the dynamics of the new economic situation: We believe the industry,
which we earlier forecast would be down 25% this year, will now be down 30% to
35%. Since Sept. 11, the SOX.X index has broken through the 400 support level.
The next support level is at 200 - the level at which the index stood in 1998.
In our view, the upturn will not be quick, given the slowing
economy in the U.S. and weakness in Japan and Asia. InsideChips sees 2002
as a long, arduous turn-around year and 2003 as a return to normal growth rates.
(Note: This review is based on historical trends and a review
of fundamental semiconductor market conditions. Actual industry performance may
differ from the analysis presented.)
Figure 2 - Philadelphia Semiconductor Stock Index