MarketWatch Commentary

The southern part of Taiwan, roughly 250 miles south of Taipei, was struck with a magnitude 6.4 earthquake at 8:18am, local time.  The epicenter was located in Jiahsian in Kaohsiung county; an area still recovering from the recent typhoon.  While Taiwan typically endures earthquakes on a regular 5-year basis, these are significant events to both human and business activities.  Thankfully no deaths have been reported at this time and no Tsunami watches or warnings have been issued.

With the epicenter located 250 miles south of Taipei, Tainan recorded a magnitude 5 while Hsinchu recorded magnitude 2 levels.  Both levels are significant and have impacted operations at these two important areas for semiconductor and LCD production due to power loss, temporary stoppages, equipment damage, and product damage or loss.  The mid- to long-term supply chain effects are forecasted to reduce or eliminate any downward pressure on ASPs, especially for panels, which were facing lowered pricing pressures.

The following are still initial reports and are likely to be modified as more time allows for more data and information to be collected:

Wafers:

• TSMC is still assessing final impact, but a minimum of 40,000 eight-inch wafers, roughly 1.5 days worth of production, was lost.  TSMC's earthquake contingency plans are in place and moving the company's facilities and processes through the disruption. (see here for source information).  The impact on 2Q10 revenue has yet to be assessed but initial estimates are at ~1%, as reported by The Wall Street Journal.
• Advanced Semiconductor Engineering, Inc. reported minor disruptions, is still inspecting packaging equipment, reviewing financial losses, but told TheWall Street Journal that production has resumed.  Bloomberg reported that the Kaohsiung plants were operating normally.
• UMC reported minor damage to some production equipment but did not report any significant impact to their operations, as reported to Bloomberg.

Displays:

NOTE: the average time that the following companies have taken to resume normal production after a temporary shut-down is 2-5 days after an earthquake, according to DisplaySearch Blog.

• Hannstar Display Corporation, had evacuated employees and shut down the factory temporarily but did not otherwise report any losses or effects on their production according to both Bloomberg and The Wall Street Journal, and confirmed by Smith & Associates locally.  DisplaySearch reports HannStar's took 3-5 days to resume production after the last earthquake. 
• AU Optronics Corporation also evacuated employees and temporarily shut down production at their Tainan facilities.  They have reported to newswires that their finances and operations suffered "no significant impact."
• Chi Mei Optoelectronics also reported temporary shut downs and evacuations but added that resumption of full production activities is likely to take one to two days, as reported by Barron's.  DisplaySearch reports an average of 2-3 days for CMO to resume production post earthquake.

More detailed information about glass substrate production is provided in detail by DisplaySearch here.

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The good news: Three years to full rebound.  2010-2013, is the general consensus forecast for the EMS industry globally to fully recover to pre-recession levels.  Conservative growth is forecasted in the 5% range and the majority of analysts (including SIA, KPMG, iSuppli, and Gartner) and economists forecast more bullish numbers in the low double digit percents, annually for those next three years (as reported in Manufacturing Market Insider  (MMI) (Vol. 20:1, January 2010, and Vol. 19:11, November 2009) and citing forecasts from InForum, SIA, IDC, and Electronic Trend Publication). 

EMS companies have been faring well, relatively speaking, and the strategic moves to diversify into new markets with important core capability links has analysts and market researchers generally more bullish than conservative. 

What is particularly interesting, as we continue to watch the ongoing EMS-ODM turf war (cf. MarketWatch Quarterly Vol. 1:1, "EMS/ODM a Mixed Market;" and Vol. 2:2, "Co-Evolution and Organic Growth"), is the varied strategies EMS companies are embracing.  As well presented in the latest MMI (Vol. 20:1, pp. 1-4) report, some EMS companies are following a new, retail path (e.g., Hon Hai's retail outlets); some are expanding to sister industries (e.g., Jabil's venture into solar panels and medical disposables); some are supporting new supply chains for the still fragmented clean/smart technologies (cf. the latest MarketWatch Quarterly Vol. 3:4, now available to subscribers and next week to the public); and some are engaging in more traditional M&A deals to expand their market reach and capabilities (e.g., Celestica's acquisition of Invec Solutions, as reported in MMI Vol. 20:1, pp. 2, 7).

Among the other trends forecasted by market analysts, we should see a resumption of more normal consolidation numbers for small- to mid-sized companies, renewed momentum for regionalization/localization (cf. MarketWatch Quarterly Vol. 2:3, "An Expanding European Microcosm" for more discussions on localization), and continued distinctions between EMS and ODM businesses but with increased "credibility to a hybrid strategy" (MMI Vol. 20:1, p.4).

The next one to three years hold promise for the EMS sector, and based on early analysts' reports for 2010, the new market opportunities may provide important growth for EMS in directions beyond the past 'turf wars' with ODMs.

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This weekend's 6.4-magnitude earthquake was one of the most intense to affect Taiwan in three years.  Although it was centered offshore to the East, this high-magnitude earthquake shook the capital of Taipei for over three minutes according to various news sources such as here, here, and here.

Beyond the human safety and impact concerns, also of importance for the semiconductor and electronics industry, is the impact that the earthquake and aftershocks will have on the local manufacturing.  With supply already short for netbook/laptop panels, as MarketWatch Commentary posted here last week, the impact of this earthquake looks to be significant for the TFT-LCD production lines and will likely result in pricing increases due to an already forecasted tight 1Q10 supply.  The best details available thus far, are found in this very informative article from DisplaySearch:

"In the middle and southern parts of Taiwan-where several AUO, CMO and HannStar fabs are located-the earthquake interrupted production for one day. Many work-in-process panels fell and broke, so they will be scrapped. The transportation systems and cassettes in clean rooms were shaken violently, and some were damaged, which will affect the throughput of the production lines. Although there is no known damage to the major in-line equipment, several production lines had to be stopped and the calibration checked.

As engineers complete their assessments, fabs resumed production gradually starting Monday (December 21), and are expected to recover completely within a few days. We estimate that roughly 1.0-1.2% of TFT LCD supply will be lost, and Taiwan accounts for 38-40% of global capacity."

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We originally asked the question, 'The $787+ Billion Question: Will semi be stimulated?' with the answer being paraphrased as 'likely, but in due time.' 

As stimulus (ARRA) money continues to fund projects intended to stimulate the US economy and workforce, and with the project mandates, particularly from the Department of Energy (DOE) and the Department of Labor (DOL), including the requirement to show measurable, positive economic impact in the short-term as well as long-term, it's time for MarketWatch to review the 'when' answer provided above.

Some of the larger grants from DOE are co-funding critical 'Smart Grid' and 'Smart Meter' projects that are not only moving the US more quickly on a renewable energy track, but are having significant stimulating effects on the semiconductor and electronics industries.

The Smart Grid, and the requisite smart meters to enable the Smart Grid, is, for semiconductor interests, essentially, a bidirectional communication system.  This entails not only an increase in hardware that now is no longer an analog device, but a bidirectional digital device, the smart meter, that also opens the floodgates to the consumer market in the form of various in-home and business devices which allow the energy consumer to directly govern their energy use in real, or near-real time.  The interactive devices, the ability of new consumer devices that can be governed, as well as the meters themselves all point in one direction:  Semi is quite certainly being stimulated and the clock has now been quite certainly started.

A cautionary note:  with SEMI's book-to-bill numbers just out, and the outlook holding steadily in positive territory (happily) but with only slow capital expenditures (CAPEX) increases, will the industry be ready and able to handle these stimulating events?

In the next issue of MarketWatch Quarterly, due out in January, watch for a focused analysis of the effects of the enactment of the smart grid and smart metering technology on the semiconductor and electronics industry. 

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As we have been gauging the health and recovery of the industry, sub-sectors, and data that indicate the path forward, now that we are in the final quarter (4Q09), it is a good time to take a look back at the EMS and ODM sector, the 'mid-stream' section of the semiconductor and electronics supply chain.

As 3Q09 reports begin to trickle in there are positive indicators that indeed, the recovery is upon us, though no one is expecting a spike that is sustainable just yet. With the retrenchment of so many along the supply chain to reign in inventory numbers, protect margins and safeguard company health, there were also the opportunities for acquisition, mergers and JVs, as discussed here and here in earlier MarketWatch Commentary posts.

In sum, both the EMS and ODM sectors are down in double digits YoY, but ODMs appear to be doing better overall, as nicely summarized in Manufacturing Market Insider's recent September 2009 issue (Vol. 19:9, pp. 1-6). 'Doing better' doesn't mean positive numbers just yet, rather, not as down as EMS. "Large Taiwan-Based ODMs" are down -9.9% for 1H09, while the "largest EMS providers" were down -19.2% for the similar time period, including Hon Hai in the group (MMI 19:9 p. 3, 1); without Hon Hai, the decline would be -27.1%.

Why the difference between ODMs and EMS? One critical variable is the inventory realignments. EMS companies certainly felt considerable stress from both sides of their supply chains as inventory management issues left many EMS companies with difficult strategic decisions: working with OEMs and their downstream channel partners simultaneously, both of whom wanted inventory off of their books and docks. ODMs too felt the pinch this year, but of course with new market demands from consumers and OEMs having to reconsider margins, redesigns and innovative designs are in demand.

Those EMS companies faring the best, most notably Hon Hai, continue to do so based on "blue-chip" customers, diversification (i.e., not being a pure-play EMS) and supporting subsidiary units that can contribute and off-set other units' downturn periods. As MMI notes, though, one question about the outlier, Hon Hai, is whether it can continue to be considered an EMS or will it become more of a conglomerate? (ibid., p.3).

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It was with great excitement that I read about latest advancement in MEMS manufacturing, DigiTimes 21 Aug 2009.  While DigiTimes noted that TSMC declined comment, news is out of their "one-stop production processes" for MEMS via CMOS! 

This is BIG news.

Why?  Well, as DigTimes goes on to note, and as we know, this new processing "is expected to impact on [sic] pure MEMS IC foundries because it completes the whole production from logic IC manufacturing to MEMS IC, which is usually transferred to specialized MEMS foundries.  In addition, customers can more than halve the costs of MEMS IC production [...]."

Tell me more?! 

You can read more about MEMS and why this is important and exciting news in our last issue of MarketWatch Quarterly, "The Small Revolution: MEMS is a game changer."

What are your thoughts on MEMS?

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Of course we all know the important news out of Japan for 2Q09, the first GDP uptick in five quarters.  That's tremendous and portends serious positives for the APAC region as well as global economic recovery momentum.  But there's more to the news out of Japan: as part of the government's stimulus efforts, increases in public spending and use of public funds to bolster those private companies worst effected by the global recession have made cash available.  With an eye to increased consumer spending in Japan as well as improved export numbers, up 6.5% for 2Q09 QoQ (Credit Suisse Japan Macro Flash 17 Aug 2009), the time to invest in local companies is well aligned and is inline to support the positive trend for recovery.

At the center of upstream semiconductor news is Japan with the now-back-on-again merger of Renesas and NEC Electronic into "the world's third-largest semiconductor maker after Intel Corp [...] and Samsung Electronics Co [...]," according to Reuters recent updates.  One of the hurdles though is the amount of debt refinancing necessary and the issue of government support to the tune of roughly 200 billion yen.  This on top of Japan's recent pledge to help Elpida Memory Inc, also severely hurt by the global economic crisis. 

While MarketWatch Commentary tends to not focus on individual companies, the merger, now seen as likely to be completed in early 2010, signals important changes to the supply chain and the competitive landscape, particularly for MCU production.  As for the impact on the industry, the increase in competition is important and will be interesting to watch, particularly as chip makers were hit hard by the global crisis.  There will be an uphill period for the new merged company, likely to fall under Renesas's name, as a result of redundancies in product, design, and then the restructuring post-merger (see HERE for a pro-con summary from EETimes).

While the impact on the global supply chain is likely to be delayed until the restructuring is completed, the opportunities for Japan to restake it's claim to semiconductor manufacturing are ripe.  Along with other trends diversifying into solar PV and the help to Elpida, Japan will be a country to watch as a new, global economy awakens.

Watch for a review of the new geo-economic landscape for the semi industry in the upcoming  MarketWatch Quarterly.

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As the semiconductor industry looks to the close of August and the start of the ramp up season, analysts too are diving into the details of 1H09 to provide more substantive forecasts.

Taking a close look at Citigroup Global Markets' recent briefing, Electronics Supply Chain Inventory Update (10 August 2009), the Supply Chain for the semiconductor industry is healthy, overall.  According to the briefing, days of inventory (DOI) averaged across the entire supply chain sub-segments are now down to the healthy low 40s (now at 43 days y/y which is good for this period based on long-term trends).  "Storage, Semis, and Servers/Enterprise post[ed] the most robust improvements y/y." (Citigroup 8-10-09, EMS Industry Brief, p.1)

Not all sub-segments were improving; DOI "for passive companies declined [...] to 93, [they] remain above [...] a five-year historical average of 84 days" (ibid, p.1) along with negative trends for "Telecom Equipment and Semi-Cap Equipment." (ibid, p.2)

Citigroup recommends closely monitoring three "critical factors": (1) Demand Seasonality - currently forecasts are strong and expecting growth "driven largely by Telecom Equipment, PCs and Semi-Cap equipment" (ibid, p.3); (2) Utilization Rates - with more normal patterns emerging and close watch on utilization upstream, "supply chain companies [look] to be able to better manage utilization rates and cost structures" (ibid, p.3); and (3) Pricing Pressure - this area is becoming 'more severe' and therefore Citigroup cautions, "we are concerned that pricing pressure could actually become more acute in the near term as suppliers compete for orders and market share in order to push up utilization rates and incremental margins." (ibid, p.3)

In short, with a good back-to-school season forecasted coupled with inventory de-stocking completed, chip sales should remain positive across the aggregated electronics supply chain.

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With the latest Manufacturing Market Insider (MMI) out this week, new numbers reviewing the widespread effects of the global recession on the EMS and ODM sectors in semiconductor industry are also available.  Turns out that the lull in spending was not only the purview of the enterprise or general consumer, but extended to the corporate merger and acquisition (M&A) market as well.

MMI's numbers show that M&A, inclusive of consolidations, were down by roughly 80% YoY!  Yes, that is indeed a historic number.  To simplify, general analysts' consensus is that during economic downturns consolidations tend to rise as a result of cash-strapped corporations looking to increase margins, move capabilities back in-house, and/or simply find alternative ways to stave off insolvency or to make a market move for future expansion and market share increases by acquiring capabilities during a fire-sale.  This just didn't happen, despite what we all thought!

Interestingly, cash savings and murky outlooks seem to have been so much at the fore that even the opportunity to buy while the buying was good proved to be too risky for most.  Moreover, the historic downturn in 1H09 breaks a long-standing EMS/ODM market trend of regular M&A activity in order to increase or expand capabilities. 

As MMI notes, the lack of M&A activity in light of the EMS/ODM trend "[...] indicates that in the business climate of the first half some providers either elected to put off acquiring a new capability or decided to develop it in-house instead." (MMI, Vol.19 No.7, p. 2) 

So, what was up?  Joint ventures (JV).  Why?  Well, JVs tend to cost a lot less but come with limited risk exposure for a comparable gain in access to the desired assets or market (ibid., pp. 2-3).  Of note: MMI does not include EMS divestitures that are not retained in the EMS sector which could skew the data (ibid., p.3).

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While the market indicators are pointing towards the bottoming being reached and recovery on the horizon, the news of companies facing tough times is still par for the course.  According to last week's report by SEMI, the April Book-to-Bill ratio is up to 0.65, holding the nice upward trajectory since January's historic low of 0.47.  However, looking at the numbers, while the three-month moving average (3 MMA) for worldwide semiconductor bookings is up slightly to US $253 million, 3 MMA billings is significantly down by 11% month-over-month to US $389.9 million.

What does this mean?  As we've discussed here, as long as bookings (and billings) numbers remain low, we do not have the foundation for a healthy supply chain, to echo Stanley T. Myers, president and CEO of SEMI. 

The result?  Yes, right back where we started: unhealthy supply chains tend to mean tightening supply chains.  The most recent proof of this cause-effect is Sony's announcement last week of halving their supply chain by 2011 in order "to save at least 500 billion yen ($5.28 billion) in purchasing costs this fiscal year," according to The Wall Street Journal.  Sony's website doesn't provide any details, other than what we knew in February about the new Manufacturing/Logistics/Procurement team.   

In the face of declining revenues, many large OEMs have been rethinking their supply chain strategies to trim costs, including the practices of leaner chains and outsourcing.  We are now also seeing 'insourcing' back in vogue.  Along with these OEM supply chain strategies have come the consolidations we've seen and tracked by monitoring a set of indicators for quite a while now here and here, especially.

The fallout for the semiconductor supply chain?  As OEMs like Sony, Hitachi and Toshiba continue to follow tight supply chain strategies, more mid- to small-sized companies will disappear due to insolvency or consolidation and the sourcing of products will, therefore, also tighten significantly.

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