2011 is likely to define a turning point for growth along the global semiconductor value chain. M&A activity has been heightened, underscoring major diversification and expansion trends. This begs the question: is the present M&A trend going to leave us with only a few suppliers in any given market?
2011 is likely to define a turning point for growth along the global semiconductor value chain. For the US and Europe, 2011 is thus far bringing renewed questions of a double-dip recession (a "W-shaped" curve). This present economic volatility and lingering jitteriness continues to send clouds over the developed markets, pushing consumer and corporate confidence lower alongside stalling numbers for employment, rising fuel prices, new questions of inflation, sovereign debt problems in Europe, and US housing prices in renewed decline (see this recent analysis from The Wall Street Journal and this one from Financial Times. Fortunately, in today's global economy, there is quite a bit more to the economic landscape than these mature and troubled markets alone; you just need a global compass, as quipped here by The Wall Street Journal. This global expansion is great news for most multinationals, particularly those along the semiconductor and electronics value chains.
First the numbers: Can down be up?
2010 was certainly a rebound year, marked by double-digit growth across the semiconductor value chain. But as 2010 ended and we moved into 1Q11, global semi growth was forecasted to have an overall "soft landing" in 2011, with a roughly 5% compound annual growth rate (CAGR) (see this early iSuppli recap and forecast).
March brought with it devastation in Japan from the 8.9 magnitude earthquake, a catastrophic tsunami, multiple aftershocks at earthquake-magnitude levels, and the nuclear power plant disaster at Fukushima Daiichi (follow the situation as it evolved in Japan from a semiconductor perspective here from MarketWatch). While the Japanese disasters continue to impact life and business in Japan, many of the negative effects on the semiconductor value chain have been resolved at this point. The global supply chains for many industries were adversely affected by these natural disasters and the ensuing power problems in Japan. For the semiconductor and its vertical markets, the supply chain was able to absorb most of the disruptions by pushing through inventory that was already in the chain and by engaging quick reassignments to other fabs and assemblies at the upstream channels in other locations.
Overall, the industry growth forecasts are actually considered to be positive at the time of this publication, and the current sluggishness is seen as being in line with cyclical trends for this traditionally slow quarter. In spite of the added downdraft from Japan, the semiconductor value chain is showing very healthy signals for 2Q11, compared to traditional five to ten year patterns (cf. Citigroup Global Markets "Equities: Electronics Supply Chain Inventory Update" 5/24/11, p. 5). The growth rate for 2Q11 is seen as normalizing after the strong 2010 rebound year; forecasts for 2011 are ranging between 5-11% over a multi-year period, depending on the bullishness of the forecaster.
So, what does this mean for growth in the global semiconductor market? Are we falling behind (at the start of a bearish market trend), standing still (status quo), or are we gearing up for growth (a bullish market)? Given the industry data for the first half of 2011, and the problems facing the US and Europe, can we really believe that semi's compound annual growth rate (CAGR) will be normalized or even reach double-digits, as predicted? If so, what data should we be considering to believe this good news?
Semi's value chain health
One way to understand the forecasts for global semiconductor growth is to compare a few important data points simultaneously, such as supply chain health (days of inventory [DOI] in light of book-to-bill ratios, average selling prices [ASPs], revenue and unit growth); semiconductor content growth; and mergers & acquisitions (M&A).
Supply chain health is a critical and broad-based metric covering most of the actual business conducted along the semiconductor value chain. If we quickly skim the numbers, we see that the lessons from the global recession continue to be remembered in the semiconductor and electronics industry: lean is healthy. In fact, while some retreats in consumer confidence were hitting markets and negatively impacting demand for electronics during the first half of 2011 (1H11), the slowdown in demand was mitigated by the supply problems from the Japan disasters, leaving inventory levels in very healthy ranges. Days of inventory (DOI) for 2Q11 are expected to only increase by roughly 3 days to a 41-day level, "below the 5-year and 10-year medians of 43 days and 42 days respectively." (cf. Citigroup Global Markets "Equities: Electronics Supply Chain Inventory Update" 5/24/11, p. 5) That is exceptionally good news for the supply chain, especially given the forecasted "tempered seasonal growth" for 2Q11 around +1.8%, quarter-over-quarter (QoQ) (cf. ibid, p.5). While there were concerns about possible shortages and resulting component ASP spikes as a result of the disruptions caused by the Japan disasters, many of these concerns were not borne out (except, of course, for the Japanese automotive industry, which experienced between 48-82% declines as reported by CNN here).
Since the global recession, we have seen that the place where inventory is held along the supply chain has moved back from point of sale to further upstream. As inventory holds continue to step up the supply chain, most inventory is not even held at the OEM; rather, pressure continues to push inventory upstream now, mostly at the hub suppliers. Advantages for this change in supply chain strategy are manifold for the industry, not the least of which is tighter control on production and utilization because of where along the chain risk is carried. The tighter inventory control has lead to leaner and more efficient supply chain operations; inventory and revenue have moved to be more in parity (in line), meaning that sales are more closely aligned with inventory, resulting in reductions of excess holdings (cf. Citigroup Global Markets "Equities: Electronics Supply Chain Inventory Update" 5/24/11, pp. 7-8).
Average selling prices (ASPs) and unit sales are always under scrutiny and, most recently, we have again seen problems in the memory sector (see this recent MarketWatch Commentary discussion). While memory continues to be volatile, the forecasted growth is around the 10% range for 2011, based on the demand for tablet PCs and smartphones, coupled with strong demand for notebooks in emerging markets. Based on Credit Suisse's forecasts for 2011, we expect continued growth, albeit at normalized levels, across the global semiconductor industry for ASPs (April YoY forecast of +0.5%), unit (volume) sales (April YoY forecast of +3.5%), and revenue (April YoY forecast of +4.0%) (cf. Credit Suisse "Semiconductors: April 2011 SIA Data" 5/31/11, p. 6).
The rise in semiconductor content is a missing key to understanding why there can be forecasted growth for the semiconductor industry in spite of the volatile global economic news, especially in mature economies where most of our industry growth has originated historically. The fact is that, even if there were no increases in unit (volume) sales, the increase in the amount of semiconductor content per device is such that the industry would see a 14% CAGR, according to analysts at Credit Suisse (cf. Credit Suisse "Semiconductors: 1Q Inventory Analysis" 5/12/11; pp. 1-4). The rise in semiconductor content across devices is a significant point for understanding the validity of the long-term growth forecasts for the industry.
So, are we to understand that growth for the global semiconductor industry is basically muted, or "normalized" going forward? In other words, are the double digit growth forecasts mostly behind us? How do we understand all these numbers? The simple answer: No. Double digit growth is NOT a forecast of the past, according to the data from across markets and verticals for the semiconductor and electronics industry. The reason itself is rather simple, but it is quickly muddied when averaged to the level of global trends. The mature economies are simply that, mature. It is the emerging economies that have finally reached the tipping point of being able to sustain growth. The emerging economies are the new, reliable growth centers and demand drivers across markets and verticals for products and have, therefore, been drawing the entire supply chain to invest in localized manufacturing, assembly, and distribution facilities; in other words, the patterns of M&A activity round out the data needed to understand and pinpoint semi growth forecasts.
The next growth level: M&A opportunities
Understanding where the money in the value chain is, and where shifts in the value chain's structure are taking place, gives us important insight into where and how companies are seeing and cultivating growth. Growth can be organic, that is, a company may grow based on existing expertise and capabilities by investing in capital expenditures for new or expanded facilities and lines, research and development (R&D), and expanding their existing product and component lines into related markets. Growth can also be achieved through mergers with, or acquisitions of, other companies, either to expand into new markets and products or to increase market share by expansion, as with organic growth.
Growth in the semiconductor and electronics industry will continue at a normalized pace in the mature economies. What this means is that, in those markets, growth will average just a point or two ahead of GDP, falling somewhere in the 2-5% range (see this recent review of SIA data by Solid State Technology). The double digit growth will come from the mounting demand drivers in the emerging economies of BRICS (Brazil, Russia, India, China and South Africa) and MIST (Mexico, Indonesia, South Korea and Turkey) (see this companion article on Brazil in this issue of MarketWatch Quarterly).
If we consider where sustainable growth is occurring globally now, it is from demand and consumption driven by the new middle classes in these emerging economies. To answer the question of the viability of long-term and substantial capital expenditure (CAPEX) and M&A investments in the emerging economies, we need to determine where, how, and for what purposes investments are being made along the semiconductor value chain.
Firstly, we know that emerging economies have been forecasted to outpace the developed or mature economies. "[M]any economists expect growth in emerging markets to be four percentage points higher than growth in the rich world for at least the next five years," according to this special report from The Economist. As the report details, early 2010 already saw the emerging-market corporations experiencing roughly 10% profit margins and using those gains for "reverse M&A" deals: "instead of Western companies buying cheap manufacturing in the developing world, emerging-market companies are buying sophisticated machinery [and business models] in the West."
The pace of M&A activity since early 2010 underscores the confidence in the cross-segment and cross-economy market growth opportunities. Already by 4Q10, the pace and price of M&As had heated up to the point that Gartner "warned that the tech industry is caught in a 'vortex of insatiable mergers and acquisitions' that is creating a category of 'super vendors' selling highly integrated offerings," as summarized here by PCWorld.
The point regarding "highly integrated offerings" is just as critical to understanding the sustainability of double digit growth in the semiconductor and electronics industry as understanding the emerging market relationships that are being forged. These issues are not one and the same, although, in many instances, both strategies for M&A are being pursued simultaneously (that is, to expand and integrate across market sectors and/or component capabilities as well as across geographic markets).
Secondly, the semiconductor and electronics industry was able to exit the recession with healthy cash reserves and with a pent-up requirement to improve and/or increase production capabilities (in new geographic areas, architectures, component and/or device designs, or simply by adding new lines). With additional cash from profits earned during the 2010 rebound, the semiconductor and electronics value chain is sitting in a good position to pursue sustained growth strategies (see this report, from The Economist, on 2011 record profit margins by major US firms). Furthermore, the industry forecast is for continued double-digit revenue growth during 2011, making an increase in M&A activity throughout the remainder of the year nearly certain, as suggested by this survey reviewed in PCWorld.
Finally, the continued demand for electronic devices that support multitasking and provide an anywhere-anytime experience, integrating functionality at the component level, has been a recent architectural driver in the chip industry. How best to leapfrog the research and development (R&D) needed to meet these component and device demands while balancing the market shifts in both mature- and emerging-market consumers? The answer to this business problem has been to use the pent-up cash reserves mentioned above. These reserves are not contributing to balance sheets, and so, to satisfy market growth strategies and shareholder demands simultaneously, strategic M&A activities continue to rise. If nothing else, the sheer volume and cash values of the M&A activity ought to underscore that changes along the semiconductor and electronics value chain are indeed real, indicative of confidence and growth, and highly strategic in terms of promoting integrated and geographically diverse multinational corporations.
There have been an astonishing number of high-profile M&As recently. Here are some of the more recent major stories underscoring the weight of M&A activity along the wider semiconductor and electronics value chain: HP's acquisition of 3Par after a tug-of-war with Dell was widely followed (see here from WSJ.com); Western Digital buying Hitachi's disk-drive business (see here from WSJ.com), and Seagate buying Samsung's HDD business (see here from WSJ.com); Micron's acquisition of Numonyx (see here from Micron); AT&T's acquisition of T-Mobile (see here from iSuppli); Microsoft's purchase of Skype, among other global internet deals (see here from The Economist and here from FT.com); Dell's expansion for data center business (see here from Bloomberg); Intel's acquisitions of McAfee (see here from Manufacturing Business Technology) and Silicon Hive BV (see here from EETimes); Lenovo's plans to acquire Medion AG as an excellent example of the rising 'reverse M&A' trend gaining momentum (see here from WSJ.com); MediaTek's acquisition of Ralink Technology Corporation, also possibly considered a 'reverse M&A', though Ralink had moved headquarters from California to Taiwan (see here from FT.com); and perhaps most recently in the news is the lingering question of whether or not Nokia will begin to sell off parts of its corporation, given the problems the company continues to face (see this report from Bloomberg).
A new value chain or a new set of oligopolies?
Along with all of this heightened M&A activity recently is the question that continues to be asked by many: will the end-result of these deals lead the industry into a situation of having only a few suppliers for any given market, such as we are seeing in both the HDD-drive space and the US telecommunications service-providers? There are already only a small handful of companies supporting and expanding leading-edge fabs (see here and here from MarketWatch Commentary). Is the M&A trend going to leave us with equally few corporations?
The existence of both business confidence and growth acceleration in the industry is heralded by the astounding rate and value of M&A activity recently. However, we do need to ask: will these new, highly integrated, multinational conglomerates serving both the mature- and emerging-market economies be able to survive under their own weight? Will there be enough market competition along the supply chain to allow for successful innovation and pricing to sustain consumer and corporate demand across the new split between developed- and emerging-market economies?
From the perspective of the simple success of most of today's M&A activity, most deals are strategically sound and likely to be sustainable in the long run, according to this special report and interview in Financial Times with Scott Matlock, chairman of International M&A at Morgan Stanley. However, the question of diversification and integration versus over-extension is a tricky one to answer. Perhaps only time will tell if the new conglomerates are able to handle the vastness and complexities of both integration in the semiconductor components, devices, and services they plan to provide, as well as the number of diverse, global markets they plan to operate in. Certainly, one historical lesson to keep in mind is the path of various South Korean chaebol, and how those that have survived, such as Samsung, LG, and Hyundai, continue to succeed (see this review from Financial Times).