Industry Report:

Analysis of The
Semiconductor Industry
-June 2021

Salient Points:

 Events leading to a shortage crisis

 Nature of the semiconductor industry
 Semiconductor supply value chain
 Economics of segment activity

The semiconductor industry has been gripped by a shortage and the

reason for the shortfall of semiconductors may be plain to see: The
Covid-19 Pandemic upended the global economy and distorted supply
chains. The problem was further compounded with the booming
demand for consumer technology during “The Great Lockdown”, as
consumers depended more on digital means to communicate, work
and for entertainment. And of course, add geopolitical trade
uncertainties into the mix, a perfect storm culminated in a global chip
shortage and is now reverberating across a wide swath of industries
worldwide…

(continued)
Chronology of Events Leading to Shortage of Macs and iPads will be impacted in its fiscal third
quarter 2021.
The chronology of events that led to the current
shortage crisis could be first traced back to 2019 when The ubiquity of semiconductors – found in any
US-China trade tension escalated into a tech war. At electronic device – further accentuated its modern-day
the peak of it, Huawei – one of the world’s largest significance, even to the extent the industry holds
telecommunications equipment maker – began national security importance. After all, global sales of
stockpiling chips in anticipation of being placed on the the semiconductor industry is expected to hit US$452
US Trade blacklist. The secondary effect led to what the billion in 2021 according to World Semiconductor
semiconductor industry dubbed as a ‘double-booking’ Trade Statistics1.
situation, in which other equipment makers placed
Countries that are major players such as the US, China,
more orders than what was intended for use.
EU, Taiwan, South Korea and Japan are all making
Then in 2020, when the pandemic began to spread moves to roll out programmes to invest in cutting edge
across the US, EU, China and other parts of the world, semiconductor technology and build up capacity
carmaker giants like Volkswagen, General Motors, Ford onshore. To date, close to US$1 trillion has been
and Toyota temporarily shut down production lines. earmarked by governments around the world, with
Given lower demand and a slowdown in the car market, South Korea leading the way with US$450 billion
carmakers scaled down on orders for automotive chips. committed. Meanwhile, China and the EU are also
Yet, demand for cars rebounded faster than expected trying to keep up in the race with US$150 billion and
in 3Q2020, and carmakers found themselves unable to US$160 billion earmarked for tech investment.
re-secure chip supplies as foundries had reallocated
Did it take A Shortage Crisis to Trigger a Major
the spare capacity – left by the carmakers – to fulfil
Reshuffling?
orders for consumer electronics which experienced a
surge in demand during the lockdown. There is a severe imbalance in the supply chain of
semiconductor manufacturing. For one, Asia
As the shortage unfolded, carmakers have to mothball
dominates the contract manufacturing aspect,
several plants and bracing for substantial near-term
accounting for nearly 80% of foundries and
output decline. According to an industry source and
test/assembly operations. Did it take a shortage crisis
research firm IHS Markit, 1Q21 may see production loss
to trigger governments to a strategic reassessment?
of an estimated 1.3 million cars and vans due to supply
Surely, governments should have known better?
chain challenges. Assuming an average sale price of
US$50,000 per vehicle, such production loss would The semiconductor manufacturing sector used to be
wipe out US$65 billion in sales for carmakers alone. more fragmented and not always dominated by Asia
but by the US, EU countries and Japan. In 2001, nearly
The US$450 Billion Elephant in The Room
30 firms were producing leading-edge semiconductors.
Beyond cars, the dearth of chip supplies is also quickly By 2018 – in less than 2 decades – only 5 firms remain
spilling over to other electronics manufacturers as a from only US, Taiwan and South Korea.2
slew of smartphone and consumer
The seismic shift of manufacturing activity from the
electronics/appliance makers surfaced and cited
western hemisphere to the east had to do with the
output challenges due to chip supply constraints. Apple
nature of the industry and the highly complex process
for instance has cited that up to US$3-4 billion in sales
of chip production. Firstly, setting up a single leading-
edge foundry is estimated to cost US$10 billion in

1&2
https://www.semiconductors.org 2020 SIA State-of-the-
Industry-Report
capital expenditure, notwithstanding operating costs. Typically, any modern-day electronic end-product is
Second, as end-devices get smaller and more powerful, made up of the following main types of
there is also massive R&D commitments involved in semiconductors chips: Processors – Central Processing
chip designs. Units (“CPU”) & Graphics Processing Units (“GPU”),
Memory (NAND and DRAM), Analogs, Application-
Then, there is the intangible part where no amount of
specific or Specialised Chips (FPGA, Wifi,
money could guarantee the longevity of new
Radiofrequency (“RF”) etc). For instance, a smartphone
technological designs or manufacturing techniques and
combines most of these types of chips to make the
processes. Outside the control of the companies
device.
themselves, this element has much to do with the fast
pace of innovation in the industry. Chip companies typically specialise in one type of
semiconductor chip. For instance, Intel takes the lion’s
Over the last two decades, it became increasingly
share in the CPU space while Nvidia dominates the GPU
difficult for companies to manage both the R&D at the
sector. In the Memory sector, an oligopoly exists
design front and Capex intensity at the manufacturing
comprising Micron, SK Hynix and Samsung. In another
front. Where efficiency and scale become vital,
instance, Qualcomm and Huawei currently competes
specialization occurs. Asia, which have had cost
for leadership in the 5G RF chips.
advantages over the west, benefitted from the ‘export’
of semiconductor manufacturing. As a result, this led to The semiconductor supply value chain can be sub-
a consolidation of the semiconductor industry as well divided into 4 main activities: Chip designing, Capital
as a more concentrated supply chain. Equipment Manufacturers & Materials,
Manufacturing Foundries and lastly Outsourced
Semiconductor Supply Value Chain
Assembly, packing and Testing (“OSAT”). Companies
As mentioned, the semiconductor chip supply chain is that partake in one or more activities are called
highly complex and companies tend to be specialised. Integrated Device Manufacturers (IDMs). Often, IDMs
This also means there is different margin profile of may still lease some capacities from foundries and
semiconductor companies, depending on the type of OSATs for a portion of their manufacturing needs. The
semiconductor chips they produce or production following Exhibit 1 shows some examples of companies
activity in which they undertake. Hence, investors positioned along the value chain in the semiconductor
should have a general understanding of chip types and industry.
the semiconductor supply value chain.
Exhibit 1:

Source: Phillip Capital Management; list is non-exhaustive.

The upstream begins at the chip designing phase. This local-listed UMS, AEM, CEI, Frencken and Malaysia-
phase is construed by Core Intellectual Property (“IP”) based Inari Amertron.
owners, involved in the licensing and the
Economics of Chip Production Activity
commercialisation of a chip’s architecture. They tend
to focus more on the R&D aspect and are usually Table 1 below shows a snapshot of the economic chip
fabless, depending purely on contract manufacturers production activity. Data is extracted from a report by
for production needs. There are a limited number of Semiconductor Industry Association (“SIA”) & Boston
Core IP owners/chip designers in the world and hence Consulting Group (“BCG”), titled ‘Strengthening the
command significant influence. The majority of them Global Supply Chain in an uncertain era’ – April 2021.
are Western companies such as ARM, AMD, Intel,
Nvidia and Qualcomm. Only recently, Apple began to In general, upstream semiconductor companies
design its M1 processor chip for Apple’s product line. command rather high margins as they bring the
greatest value-add compared to downstream
Then, there are the capital equipment manufacturers companies. This also translates to healthier operating
that mainly partake in the design or production of cash flow compared to downstream players.
manufacturing equipment/materials or inspection
equipment. Such systems are highly advanced and Diving into IDMs, they command a gross margin of
major players are mainly from the US, EU and Japan. about 52%. On average, capital spending accounts for
Amongst them, ASML is a Dutch-based company 34% as a percentage of revenue (“%rev”) and is spread
leading the manufacturing equipment sub-sector while between R&D and Capex because they undertake both
US-based Lam Research and Japan-based Lasertec are design and manufacturing aspects. Operating cash flow
leading players in semiconductor inspection systems. makes up about 17%rev.
Then, there are also the toolmakers that supply Fabless companies command about 50% gross margin.
components to equipment manufacturers, situated R&D intensity is the highest in this segment, making up
mostly in Southeast Asia. For example, local-listed ASTI 20%rev. On the other hand, Capex intensity is the
and Micro-Mechanics provide precision engineering lowest at only about 4%rev due to their asset-light
tools that go into such systems. model. Overall, operating cash flow in this segment is
In the mid-stream are the manufacturing foundries. about 20%rev.
They perform the main task of wafer fabrication where At 45-60%, capital equipment makers command the
microscopic circuit patterns are imprinted on wafers to highest level of margin. Capital spending is mainly
make a semiconductor chip. This is also currently focused on R&D lying in the range of 10-15%rev while
where the bottleneck in the supply chain occurred Capex ranges somewhere 3-5%rev. Like chipmakers,
because only a handful possess the most advanced capital equipment manufacturers are also asset-light,
techniques to process chips at lower nodes (“nm”). In operating on a high-value, low volume basis. They
wafer fabrication, nodes define the density of enjoy the highest level of operating cash flow at 25-
transistors and hence shrinking nodes is critical for 30%rev.
packing more performance into chips. Currently, less
than 5 foundry firms possess sub-10nm technique and Pure-play foundries see about 40% gross margin with
only TSMC possess sub-7nm technique. rather relatively low R&D intensity at 9%rev. Most of
the R&D goes into developing techniques for shrinking
At the tail-end of the supply chain are OSAT players down nodes. However, they incur the highest Capex
which offer final assembly, packaging and testing intensity at 34%rev which goes mainly into procuring
services of chips before shipping to Original Equipment equipment from capital equipment manufacturers. At
Makers (“OEM”) to produce their hardware. OSAT about 45%rev, the segment is the most intense in
players are typically situated in Southeast Asia, such as terms of total capital spend. Nonetheless, they still
generate a rather healthy operating cash flow of about Investment Positioning
15%rev.
Demand for semiconductors is self-reinforcing, in that
Lastly, OSATs have the lowest capital spend different chip types are complements and not
requirements at 20%rev. They do not perform much substitutes. This is because electronic devices need
R&D and Capex intensity of 16%rev is in the mid-range more than one type of chips to produce. Despite its
of the spectrum. Most of the Capex goes into procuring long-term uptrend, the semiconductor industry is also
assembly/packaging machinery and semiconductor notoriously cyclical in short time frames.
inspection systems. They also bring the least value-add
Putting the current dynamics into context, we are
to the supply chain and hence command the lowest
about to see a massive spur in a boost in R&D and
margin at about 17%rev. Due to this, their operating
Capex in the industry. Because governments are
cash flow stands at about 2%rev.

Table 1: Snapshot of Segment Economics as % of revenue (2016-2019)

Gross Margin R&D Capex Operating Cashflow
IDMs 52% 14% 20% 17%
Fabless chip designers 50% 20% 4% 20%
Capital equipment makers* 45-60% 10-15% 3-5% 25-30%
Foundries 40% 9% 34% 15%
OSATs 17% 4% 16% 2%
Source: SIA & BCG. *Not estimated by SIA&BCG. An estimate provided by Phillip Capital Management (“PCM”); exclude capital tool makers.
Compiled by PCM.
incentivizing firms to advance technologies and
Combined R&D &Capex Intensity (as %rev) expanding manufacturing capacities, upstream
60%
companies the likes of chip designers and capital
50% equipment makers are likely to be the direct
Foundries, beneficiaries.
40% 43%
Meanwhile, foundries will also benefit from
IDMs, 34%
30% government incentives as they boost Capex to expand
Fabless, capacities. However, in light that there is a ‘double-
24%
20% CEM, 13- OSATs, 20% booking’ situation at foundries, it remains unclear what
18% the real demand is. As such, an unprecedented
10% expansion in manufacturing capacities has the inherent
uncertainty of whether market demand could absorb
the supply.
Gross Margin-to-total capital spend%rev ratio
3.50 3.14 In addition, upstream semiconductor companies are
3.00 also more preferred in the event that interest rates pick
2.50 2.08
up. Due to their asset-light operations, rising interest
2.00 rates would have a less significant financial impact as
1.53
1.50 compared to Capex-intense operating models.
0.93 0.85
1.00
0.50
0.00
IDMs Fabless CEM Foundries OSATs

Source: Compiled by PCM

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