Arc's + Sundisk - results watch by FT
By Martin Arnold in London
Published: November 15 2000 10:58GMT | Last Updated: November 15 2000 16:04GMT
Arc International, the UK microchip designer, said on Wednesday a 30 per cent jump in licencing revenues resulting from new customer wins had boosted third-quarter turnover in its first results since its September flotation on the London stock exchange.
Net losses in the third quarter widenened by 32.5 per cent from the previous three-month period to £5.3m ($7.6m), as the company continued to increase investment in its research and development and its sales and marketing operations.
Bob Terwillinger, chief executive, said: "We believe that the business of Arc International continues to demonstrate significant growth in the number of licencees of our technology."
Its biggest customer win in the third quarter was SanDisk, a California-based semiconductor company, which has agreed to licence Arc's technology for its flash memory chips that are used in a range of wireless devices.
Arc also announced a strategic alliance with Xilinx of the US that it says will give it the technology to build the systems it designs directly onto a microchip, rather than having to outsource it to a semiconductor foundry.
The company said the deal would enable it to make its new Tangent A4 processor available in Xilinx devices from a worldwide network of design centres.
Third-quarter turnover was £5.3m, compared with £4m in the second quarter. Soaring demand for the chips used in wireless digital devices helped it increase its design licences from 44 to 56 and its customers from 28 to 35.
Its balance sheet has been bolstered by the £126m the company raised from its flotation and it had net assets of £169.4m at September 30.
Shares in Arc fell more than 3 per cent to 274-1/4p in early trading on Wednesday. They have fallen steadily from their high of 429.51 shortly after their IPO, but are still above the 210p issue price.
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Chip special: Feast or famine
By Tom Foremski - Nov 13 2000 20:25:45
It is sometimes said that the complex economics of the chip industry are best understood by studying the menu at the Semiconductor Industry Association's annual dinner in November.
During leaner years, the fare is rubbery chicken and pasta. This year, about 1,000 senior chip company executives from around the world gathered in Silicon Valley to feast on roast duck, rack of lamb and sea bass, washed down by generous quantities of California's finest wines.
Yet if Wall Street analysts had their way, the chipmakers would have had to make do with bread and water.
The divide between the bearish outlook of the Street and the bullish forecasts of the industry has rarely been greater - and it is a sore subject.
Business leaders such as Craig Barrett, chief executive of Intel, the world's largest chipmaker, have recently expressed frustration with analysts' views. And, at a press conference just before the SIA dinner, Jerry Sanders, head of Advanced Micro Devices, lashed out at "idiots" and "jerks" among analysts and the media.
The reason for this frosty relationship is not hard to find. For several months now, Wall Street has been predicting that a downturn is likely to hit next year - much earlier than the industry expects. That is being blamed largely on heavy spending on new chip production capacity and slowing growth in sales of personal computers and wireless and communications applications.
The industry, perhaps unsurprisingly, disagrees. Both the SIA and Dataquest, a leading US market research company, predict the downturn will not hit until late 2003 - and even then, growth is expected to be about 10 per cent that year, before climbing almost 17 per cent in 2004.
"We have always had four-year cycles and we are in the middle of the second year of an upward cycle. These cycles are immutable," says Doug Andrey, the SIA's chief economist.
That has not been much help for chip company stocks. Shares in market leader Intel, for example, reached a 52-week low of $35 on October 17. The stock has since regained some ground, but remains well below its year high of nearly $75, reached on August 23.
Meanwhile, the Philadelphia Semiconductor Index, representing a basket of chip and chip equipment companies, is almost 50 per cent below its year high of 1,332.73 of in mid-March.
Part of the slide in chip stocks may be down to the chipmakers setting high expectations for some markets, such as mobile phone handsets. Motorola and Texas Instruments, for example, issued bullish handset forecasts earlier this year - which they subsequently had to back away from.
"Yes, the number of [mobile phone] handsets won't be as high as 510m units shipped this year and more likely in the 415m unit range, but there is still very strong growth in these markets compared with last year," says Jim Handy, chief chip industry analyst at Dataquest.
Mr Handy believes there is a "huge" gap between the analysts' view of the industry and what is a very robust chip market. "The chipmakers are excessively undervalued right now, in the same way that they were over-valued earlier this year," he says.
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Chip companies have reported quarter after quarter of record revenues and earnings - and the SIA last week increased its forecast of revenue growth this year and for the next three years. It is confident that revenues will rise 37 per cent this year to $205bn.
Growth rates next year are forecast to rise by a more modest 22 per cent, to reach nearly $250bn, and the industry is on track to hit $1,000bn in revenues by 2010 or 2011.
One of the main driving forces behind this predicted growth is the fundamental shift in the make-up of the market. The personal computer industry is no longer the main driver of chip demand. Wireless, communications, data networking, consumer electronics products, broadband and optical networks have all emerged as large customers.
"The industry is still cyclical, but with a more diverse set of customers, the downward cycles in the future will be moderated and less severe," says Wilfred Corrigan, chief executive of LSI Logic, a US chipmaker.
Wall Street, however, is concerned about chipmakers' spending plans; lower mobile phone shipments; slower growth in PC markets; and the ability of debt-laden telecoms companies to maintain high spending on faster communications infrastructure.
While capital expenditure on new chip facilities is at record levels - at about $60bn this year - it is still moderate as a percentage of total chip revenues, at about 28 per cent. Makers of chip manufacturing equipment have been hit by downgrades along with the chipmakers, but business remains strong.
Moreover, there is a big shift coming next year to processing larger 300mm silicon wafers that will require increased amounts of expensive production equipment. The bigger wafers enable roughly twice as many chips to be produced per wafer, cutting manufacturing costs.
Another moderating factor is the speed at which additional plants can be built. Most of the factory "shells" left over from the previous "bust" phase of the industry cycle have been snapped up. For example, in September Atmel, the US chipmaker, acquired a Siemens facility in north Tyneside, England, for about $100m. This means "greenfield" sites have to be developed, typically taking about two years to reach full production.
There is also a shortage of the steppers and scanners used to create the microscopic circuits - vital pieces of chip production equipment that have lead times of 14 months or more.
"Lenses for high-end scanners have to be built by growing special crystals, and there is not enough of this material," explains K Bala, senior vice-president of manufacturing capability development at Texas Instruments. He expects this shortage to delay TI's ability to build state-of-the-art chip facilities by four months or more.
"This happens every time the industry shifts to a new process technology. The learning curve is always painful," notes Dataquest's Mr Handy.
These factors will limit the speed at which production capacity can be added. That, in turn, should mitigate the downward pressure on chip prices that greater supply is likely to bring.
The expansion of the chip market globally has also changed. The SIA's most recent figures show a more equal distribution of global consumption and production. Ten years ago, Japan held 39 per cent of the market, followed by North America with 28 per cent, Europe 19 per cent and Asia-Pacific 14 per cent.
This year, North America holds the lead with 31 per cent, Asia-Pacific has grown to 25 per cent, Japan has fallen to 23 per cent and Europe has increased to 21 per cent. The Asia-Pacific region, outside Japan, has shown the strongest growth. In Taiwan, large investments in foundries, which make chips for other companies, have paid off handsomely as leading chipmakers have outsourced some production.
Taiwan's foundries, dominated by Taiwan Semiconductor Manufacturing and UMC, have production costs among the lowest in the world. But while analysts there remain relatively upbeat about the prospects for Taiwanese chipmakers, the local stock market is unconvinced. Shares in both TSMC and UMC have been punished in recent months, in contrast to the roaring production, generous margins and soaring sales reported by both groups.
Elsewhere in Asia, the picture is mixed. South Korean chipmakers have focused on the volatile market for D-Ram memory chips, which has continued to suffer from price declines - despit earlier predictions of shortages and firmer pricing in the second half of this year. Spot prices for D-Rams have declined recently to about $3 for 64 megabit chips and $8 for 128Mb chips.
Samsung Electronics has done relatively well, but Hyundai Electronics is struggling with huge debts that limit its ability to keep up in the race towards lower production costs through investment in newer chip-making technologies.
European manufacturers have enjoyed a resurgence, thanks to the surge in demand for communications chips, which has helped propel Infineon, STMicroelectronics and Philips into the top 10 global chip companies.
"Who would have predicted 10 years ago that three European chip companies would be in the top 10? It is a clear demonstration of the growth in communications," says Mr Corrigan at LSI Logic.
The Europeans are also less exposed to the PC sector than some of their US rivals, notes Peter Knox, analyst at Commerzbank. Although Germany's Infineon is in the D-Ram market - and warned last week that it expected weaker demand and lower prices in its memory business in the first quarter of fiscal 2001 - it hopes production of next-generation memory chips will offer higher margins.
Infineon, STM and Philips have recently forecast revenue growth of about 30 per cent next year, ahead of the industry average. Even so, share prices of European chipmakers have been caught in the downdraft from the US.
Jean-Philippe Dauvin, chief economist at STMicroelectronics, notes: "The market value of STM is half what it was earlier this year. But the price of chip production equipment has not fallen by half. That means it is more difficult to raise the $1bn-$2bn in capital markets for new facilities."
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In Japan, chip companies have lost market share in recent years because of lower capital expenditure and an earlier dependence on the hard-hit D-Ram market. Despite that, the SIA still considers Japan a fast-growing market, in that purchasing of chips is expected to increase significantly over the next two years.
Japan's chipmakers may have lost their lead in D-Rams to the South Koreans, but they still hold about a 20 per cent share of that market. Their key strength is in chips for consumer electronics products.
However, the difficult domestic economy has affected Japan's chipmakers. "Japan's semiconductor companies under-invested in capital expenditure because the profits from chips were siphoned off by their parent companies," says Mr Handy.
It is the US chip makers that dominate the industry, however. Intel, while heavily dependent on the PC market, is expanding aggressively into communications-related chips, and doubled its capital expenditure budget this year to $6bn. Micron Technology, the world's largest maker of D-Rams, has sought to combat declining prices with more efficient production.
There are some valid short-term concerns, such as higher chip inventory levels at network equipment makers Cisco Systems, Nortel Networks and Lucent Technologies. And at the handset manufacturers, that will take a month or two to work through.
However, the SIA figures clearly show the industry is very healthy with plenty of room for substantial growth next year, with the downturn solidly two years away.
And, as AMD's Mr Saunders notes, despite Wall Street's bearish views: "We are making tremendous amounts of money."
Additional reporting by Paul Abrahams in San Francisco, Mure Dickie in Taipei and Caroline Daniel in London
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