09:42am EDT 21-Sep-99 CIBC World Markets Corp. (Adams, Robert C. 415-399-5744)
Semiconductor...: Taiwan Earthquake Early Report: Disruption Short-term
CIBC World Markets
Semiconductor Food Chain
Robert C. Adams, CFA (415) 399-5744
Ali Irani (212) 667-4233 September 21, 1999
Ken Pearlman, CFA (415) 399-5730 Taiwan Earthquake Early Report
N. Quinn Bolton (212) 667-8680 Disruption Short-term, Manageable
* We are making no changes to estimates or ratings at this time to our
semiconductor and equipment universe following a major earthquake measuring 7.5
on the Richter scale that hit Taiwan -a major electronics manufacturing center
and home to the world's two largest foundry operators-- early Tuesday (09/21/99)
at 1:47am local time. The quake, centered near the city of Nantou in central
Taiwan, is the strongest in ten years on the island and, while damage assessment
to Taiwan's infrastructure remains difficult, it is at least responsible for
complete loss of power throughout the island after two power plant shutdowns.
* While we are currently unaware of the complete scope of damage to Taiwan's
semiconductor manufacturing industry, we believe that the uncertainty of supply
disruption could result in near-term volatility in shares of fabless
semiconductor stocks that use TSMC or UMC as their foundry choice. Together
these two leading foundries provided 48% of worldwide fabless wafer supply in
1998 (Exhibit 1, page 2). In our semiconductor coverage universe, those fabless
companies include: Altera (ALTR), DSP Group (DSPG), Xilinx (XLNX), PMC-Sierra
(PMCS), Zoran (ZRAN), and Genesis Microchip (GNSS). Additionally MPU suppliers
AMD and Intel could also be affected because, although each produces its own
devices, approximately 1/3 of the world's motherboards are assembled in Taiwan.
* Our early calls to industry participants with manufacturing facilities in
Taiwan -including to TSMC, and UMC partners and customers-- indicates that
ahead of announcements by both TSMC and UMC in the next 24 hour, the structural
integrity of fabs of both foundry operators appears to be maintained, and that
they are running on standby power generation in the near-term. Limited damage
to fabs -typically equipped with strong vibration dampeners to protect billion
dollar investments-- concentrated in the Hsinchu Science Park may be also
contributed to the lower 5.0 magnitude of the earthquake in that location,
helping to minimize a sustained production shortfall.
* If these initial reports prove correct, and damage to fab facilities remains
contained, we expect that the biggest issue will be the speed at which the
Taiwan's power grid can be restored to replace emergency generators which are
typically only prepared for 24 hours of operation. Any delay in restoring power
would require that power hungry fabs systematically shut down equipment in a
managed process, but would in our opinion only prolong the resumption of output
by a limited period of time only. In either case, we believe that it is safe to
assume minimum supply disruption of at least two weeks and perhaps as long as a
month while all the incremental contamination is cleared, advanced equipment
within fabs is recalibrated and production rates, yields and incremental tooling
of facilities return to normal levels.
* Further, we believe that external factors could mitigate any near term
shortage of product from Taiwan. First, many semiconductor suppliers have been
building inventory in advance of an anticipated strong holiday buying season,
potentially buffering any limited near-term supply problems. Second, we
believe that customers have been ordering extra inventory to prepare for
potential Y2K related delivery problems, and as such we believe they may also be
holding buffer stock.
* As for equipment vendors -including Applied Materials and ASM Lithogrpahy
which have high share of their respective markets in Taiwan-- we believe that
the impact of the earthquake is also likely to prove minimal as long as the
structural integrity of fabs is maintained. In the very short term only, while
internal fab resources are diverted to recalibrating and restarting equipment,
some new tool installation may be delayed, a hurdle which equipment vendors can
help minimize by allocating their own local service staff to the problem as
well. In the longer-term however, we believe that with end-market demand in the
semiconductor industry remaining robust on a worldwide basis and capacity still
in tight supply, the Taiwanese industry -which we estimate to represent 18% of
global Cap-Ex next year (Exhibit 2, page2)-- is only likely to accelerate
deliveries through 2000 whenever it can.
* Given that we see little initial earthquake damage at Hsinchu, and that we
believe companies and distributors may currently have higher than average
inventories, we expect that there will be little effect on the fundamental and
long-term businesses of semiconductor suppliers, their customers and equipment
vendors doing business in Taiwan. While investor sentiment could negatively
affect these stocks in the near term, we believe that any significant related
correction, in the 5%-10% range, would justify accumulation of the affected
stocks: Fundamentally, the demand cycle remains intact, capacity is in short
supply, and pricing trends - and thus margins and cash flows-- remain favorable
throughout the semiconductor food chain.
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