What do the emerging economies tell us about semi growth? Quite a bit, particularly when we consider forecasts for growth and market expansion. Is there a renaissance for semi? In some ways, yes, and the opportunities are found in places like Brazil and are already being aggressively funded, yet not without some risk.
Developed economies like the United States and Europe are forecasting Gross Domestic Product (GDP) rates in the 2-4% range year-over-year. While this modest level of GDP growth is reasonable for mature economies, it necessitates a search for new double-digit growth opportunities for the entire electronics value chain. Furthermore, mature economies continue to face stalls in economic momentum with lingering post-recession dampeners (see this Bloomberg article on US stalls), leaving a set of new market stars to shine more brightly and attract significant business and financial attention (cf. this recent Financial Times article, and here and here from The Wall Street Journal (WSJ)).
Where are these new market stars? Two groups of nations have been identified as the next tiers of emerging economies taking center stage as rising political, economic, and financial powers (see this from WSJ and this from Bloomberg). The first is called BRICS, which stands for Brazil, Russia, India and China and the recently added nation of South Africa (see this from Bloomberg). The BRICS nations are the leaders of the emerging economies, along with a new, second group of emerging economies called MIST (Mexico, Indonesia, South Korea and Turkey (see this recent press release by The World Bank). So what do these groups of emerging economies tell us about the prospects for continued growth for the semiconductor and electronics industries? Quite a bit, particularly when we consider the opportunities for growth and market expansion.
Given that the semiconductor industry itself is facing sector slowdowns due to reaching next levels of maturity, such as in parts of the PC market, the entire global market place should be mined for new growth sector opportunities. That is, it is important to consider where profit and volume opportunities are best found for the full spectrum of the semiconductor industry's market sectors and entire supply chain, from rare earth minerals and ore through the manufacturing and assembly process, on to the sale of electronic products. Considering this is the entire electronics value chain, are we looking at a renaissance for semi? In some ways, yes, and the opportunities for expansion and new market shifts are present and already being aggressively funded, yet not without some risk.
The emergent shift
Within the semiconductor and electronics industries, market concerns include what seem to be a never-ending list: the impact of tablet sales on traditional PC products, supply constraints from disasters, raw material (such as rare earths) procurement and pricing, and lingering questions around the durability of consumer and business confidence, for example. The question of demand, in the wake of the global recession, continues to make all business sectors nervous. Not the least of analysts' and strategists' worries are the impacts of rising oil prices which dampen spending globally; continued inflation affecting many of the new, emergent, global middle classes; the ongoing instability in the Middle East; and volatile exchange rates for key currencies. Each one of these macro-economic variables translates into potential problems at the purchase point for business and consumer confidence to purchase and upgrade electronics, as well as with profit margins.
While considerable attention has been paid to India and China in the semiconductor industry press, Brazil has been strategically increasing its role in the global political and economic arena, such as winning the hosting privilege (and expense) of the 2014 World Cup and the 2016 Olympics. Brazil's rise in profile and voice has also raised considerable business interest from both its sister emergent economies in BRICS and MIST as well as from the US and Europe (EU), particularly regarding technology improvements and adoptions (see this WSJ case study).
A new world power
Brazil's rise to global player is not an enigma. Brazil’s population is over 194.2 million and São Paulo, its largest city, holds the rank of the fourth largest global city. Brazil boasts a steady GDP that has risen from 5.0% in 2009 to a forecasted 7.5% this year, positioning it as the seventh largest global economy and widely agreed to be one of the most rapidly growing and developing economies in the world. Brazil's demographic and economic growth are cornerstones of new opportunities for businesses across industries, particularly those seeking double-digit growth numbers like the semiconductor and electronics industries. This business opportunity confidence is evidenced in a 2011 assessment rating of 70% of private equity investors favoring Brazil over other economies for investment purposes, China comes in second at a 60% level. Why should we in semi care about private equity investment (PEI)? Because PEI numbers are data that underscore confidence in growth within an economy based on import-export levels as well as internal growth fostered by favorable labor and consumption conditions. These 'favorable conditions' mean that there are new and strong business plus consumer demand drivers for the (high tech) tools that support modern life, from commerce to telecommunications and modern social networking through electronics; these are the data that are boosting the global PC forecasts (see this report by Reuters). For example, according to this summary from Telecompaper, the "Brazil Quarterly PC Tracker research by IDC Brazil has concluded that 3.6 million computers were sold in Q1 2011, 22 percent more than Q1 2010." We have seen in Brazil the leapfrogging capabilities of industry growth, such as the productivity gains experienced in two of Brazil's major industries, agriculture and oil and gas. These productivity gains are due to the investment and adoption of technological solutions to improve business processes, yield, and profitability. With these IT solution adoptions come investments in hardware and hardware infrastructures that provide and improve the technological foundations for successful, modern business.
Further confirmation of the viability of Brazil as a new global, political, and economic center can also be measured in the respect and interest Brazil is receiving from other nations as a trading partner (presently focused on commodities, though with Brazil's intense desire to balance that out with manufactured goods); as having a leadership voice in the G20 and Doha groups; and as a strategic location for new factory and logistics hubs (see some of the recent trade negotiations with the US here, here, here and here; with Russia here; with China here, here and here; with Argentina here and here; with Israel here, to list just some recent examples in 2Q11). This long list of international trade talks and negotiations underscores the growing global importance of Brazil to a variety of economic powerhouses. More tangibly, in 2009, China overtook the US as Brazil's number one trading partner (see this 2009 article from BBC News). Also evidenced by the number of high-level negotiations and meetings in Spring 2011 alone is the active engagement by Brazil's new president, Dilma Rousseff, to lower the tariffs and hyper-protectionist trade barriers that were common under Brazil's former President Luiz Inacio Lula.
Why should the semiconductor and electronics industries take heart in all of these 10,000-foot view changes in Brazil's political and economic positions? If none of the reasons listed thus far have been compelling enough, the anticipated returns and economic benefit from the extraction of oil and natural gas from Brazil's largest offshore reserve (see here for a 2005 report from the BBC), the subsalt region located off the coast of Rio de Janeiro and controlled by Petrobras, should be an obvious signal of shift in the global power structure. The subsalt region is estimated to be "the size of New York state, [and] is believed to hold more than 50 billion barrels of oil, enough to supply all U.S. consumption for more than seven years," according to this analysis from Reuters. Couple the positive economic and political impact that this amount of oil holds for Brazil with the Brazilian government's interest in promoting rare earth mining domestically to add another level of independence for Brazil while attracting and supporting various high-tech sectors (from clean energy to semiconductor manufacturing), as discussed in this recent Reuters article. Having both fossil fuel and rare earth reserves creates a compelling draw for semiconductor manufacturing, new sector sales, and investment.
There are significant rewards, as well as noteworthy risks, to investment in Brazil, as with any emergent business scenario. However, the opportunities for new and sustainable double-digit growth in Brazil are not only viable, but already being capitalized on by many of the largest semiconductor manufacturers, assemblers, and OEMs in the industry.
Semi's positive market analysis for Brazil
The proof is in the pudding, after all, so what opportunities exist for the semiconductor value chain? The following summarized market analysis underscores the risks counter-balanced by the rewards for semiconductor investment in new and expanded facilities for manufacturing, assembly, and sales in the Brazilian market.
There are clear risks for semiconductor value chain businesses in Brazil. Not the least of these is overcoming Brazil’s history of business, political, and economic protectionism and opaque fiscal and business practices. While President Rousseff's four-year term only began in January of this year, she has already made a positive global impression due to her ability to quickly mobilize non-protectionist positions in government relations and trade negotiations while initializing fiscal transparency and the installation of committees to guide and aggressively manage Brazil's multiple economic and business challenges. With a strong and globally favored leadership, the leap of faith has shortened for investors and corporations to believe that positive changes are viable and not short-lived in today's Brazil.
Fiscally, Brazil's present problems include a highly volatile and soaring currency exchange (the real is up roughly 40% over the US dollar in the past two years) coupled with high inflation (6.5% monitored here, and this recent forecast for 2012 inflation rates, as reported by Bloomberg), which negatively impact domestic and international commerce (see here and here from The Wall Street Journal). The problem with a strong currency in today's global economic trade arena is that the cost of goods exported becomes too high from a multi-national perspective because the exchange rate depreciates companies' profits. Add the problem of strong currencies for trade balance to Brazil's high inflation, then even locally manufactured goods that are meant to be sold in the domestic market suddenly are disadvantaged to imported goods which can still be profitable at lower prices.
Contributing to the inflation problems are two serious domestic issues: increased access to credit and what is called an 'over employment' situation (meaning that there is a deficit in labor market causing problems in securing skilled labor and driving up wages) (see here and here). Brazil's unemployment rates have been falling to record lows (December 2010 closed at 5.3%, as discussed in this Bloomberg business analysis of Brazil). The short supply of skilled workers means that wage increases further reduce the profitability of manufacturing or assembling goods in Brazil. Also, the ease of credit availability (the lending rate recently increased to nearly 12%, as commented on here by Financial Times), fuels domestic spending and feeds the inflation rate because this situation encourages demand and purchasing over a supply-side situation. A supply-heavy situation would encourage lower interest rates to fuel demand and spending (such as those economic policies being implemented in the US and Eurozone to spur spending post-recession).
These data alone might make one wish to turn the page in search of the next emerging economy to seek a safer haven for market opportunities. However, with risks laid forth, the rewards and strengths of the opportunities in Brazil need to be considered because many believe they outweigh these not insignificant risks (see this analysis from Bloomberg).
One litmus test for confidence in opportunities and the viability of expanding and constructing semiconductor manufacturing and assembly in Brazil is what the major companies in our industry are doing. Foxconn/HonHai is no stranger to Brazil and has recently been in talks with President Rousseff during her Spring visit to China. On the table is US $12 billion in investment to add to existing facilities in Brazil and move from assembly (with imported components) to localized manufacturing and assembly (see this article from The Wall Street Journal). Brazilian confidence in the continued expansion of China-Brazil trade volumes can be counted in the present construction of a US $2.6 billion "superport north of Rio de Janeiro for massive tankers headed for China." (as discussed here by The Wall Street Journal)
If one considers these public investment announcements as encouraging, there is a long list of other businesses also expanding their Brazilian footprint, such as medical, aerospace, defense, information technology, telecommunications, and the full array of consumer electronics and household appliances. With the historic low unemployment levels and increased access to credit, Brazil's emerging middle class is a demand variable that cannot be ignored by the semiconductor and electronics industries. With over 80% penetration rate for mobile phones already in 2009 (see this CNN market review), and the movement toward 4G and increased network capabilities supported by global telecommunicaiton giants such as Tel Italia (see this from Reuters) and America Movil (see this from Reuters), there is an existing, solid market for handsets ranging from low-cost to high-end; this is a critical strategic point for the electronics market, and speaks to the US $12b Foxconn HonHai is interested in investing (given their percentage of Apple's iPad2 and iPhone production, for example).
Beyond this single example of consumer electronics and mobile phones are the data showing the importance of the Brazilian market demand for the broader PC sector, which continues to grow at double digit rates year-over-year (see here and here). Additionally, data from one of the major Brazilian appliance retailers, Magazine Luiza, definitively shows that demand is strong in the home appliance market with same store year-over-year sales increases averaging 25% (see this Reuters report). And further fueling the demand drivers for semi in Brazil is the resounding strength of the auto industry forecasts (see this example from The Wall Street Journal).
Adding to the demand strength from both the emerging middle class and corporate growth are the favorable moves by President Rousseff's government to lower the cost of certain goods as part of broader trade and investment negotiations. One critical and economically opening move by Brazil is the 36% anticipated price drop in tablet prices due to new government tax breaks for certain companies manufacturing in Brazil (e.g., Positivo Informatica, Motorola, Samsung, Foxconn, and ZTE, according to this Bloomberg report). Given that Brazil had once been a net manufactured good exporter, but in the recent past moved back to commodities, the trade imbalances and negative impact on Brazil's domestic economic situation has taught the present administration that improving conditions to support a resurgence in manufactured goods export is imperative to stabilizing and successfully growing the nation's booming economy.
On the mixed front is the fact that Brazil is in serious need of infrastructure expansion and improvements due to present logistics problems for both goods and people in this large country. With the 2014 World Cup and 2016 Olympics quickly approaching, Brazil is realizing that it must seek external investors to ensure that it has the airports, roads, buildings, technological, and electric power infrastructure, among other necessary services to support the inundation of athletes and tourists. From an analyst's perspective, if for no other reason than global showmanship, there are considerable pressures on Brazil now to quickly rise to various challenges and realize its new political and economic prominence on the world stage. For the semiconductor industry, the situation in Brazil points to positive reasons to invest and expand in Brazil. Additional demand drivers include the fact that 50% of Brazil's population is part of the emerging middle class demanding new and upgraded consumer electronics, improved telecommunications, household appliances, green power options with smart meters, and new automobiles complete with the infotainment options driving automotive semi globally.
In short, emerging economies, such as Brazil, will always carry a level of inherent risk over mature economies. However, as mature economies continue to experience growth slow downs and plateaus in the single digits coupled with lingering uncertainties around consumer and corporate confidence for spending, new risk factors now also reside in mature economies. As a result of our present global economic situation, growth strategies require the acceptance of new types of risks. Double digit growth continues to be available for those businesses that recognize the fast rise in importance of the new classes living in emerging economies. Recognizing where the next generation of steady and hungry demand drivers will come from means recognizing the need to expand globally into these emerging economies. The time is ripe for investments in local manufacturing, assembly, and distribution to take advantage of the forecasted growth and profits for the wider semiconductor and electronics industries from the new emerging middle class.