Is undercapacity looming?
Jennifer L. Baljko and Will Wade
Pebble Beach, Calif.- Analysts and industry experts rang in the new year with conservative optimism about the semiconductor market at the Semiconductor Equipment and Materials International Industry Strategy Symposium (ISS) here last week.
Marking an end to the three-year chip recession, eager forecasters said 1999 holds promise for the sluggish IC community, with growth projected in the mid-single- to low-double-digit range.
While the number could shoot up considerably if global economies, inventory levels, and end markets improve in the next 12 months, confidence in the overall business climate is being slightly dampened by the lingering concern about overcapacity in the chip-manufacturing pipeline and lower levels of capital spending, analysts told equipment makers at the conference.
How chip suppliers address those issues will affect the way goods are bought by OEM purchasers, who in recent months have grown accustomed to having a glut of product available at lower ASPs.
The consensus among industry watchers is that supply and demand will come into balance by the second half of the year. But if suppliers continue to tighten their capital-spending budgets and OEM buyers start boosting inventory levels too quickly, undercapacity problems could crop up in the short term, said Jean-Philippe Dauvin, chief economist at STMicroelectronics, Lexington, Mass.
"This business is driven by capacity," Dauvin said. The semiconductor industry typically is not in sync with spending requirements, so it is always in an overcapacity or undercapacity situation, he added.
By cutting spending in 1997 and 1998 to 29.2% and 22.7% of sales, respectively, compared with 33.7% in 1996, the chip industry showed prudence, analysts said. This year, though, the average chip company will invest only 19.1% of revenue in capital expenditures, instead of the preferred average of 21%.
Capital expenditures in the global chip market this year are expected to reach only $25 billion, compared with $28 billion in 1997 and $40 billion in 1996, Dauvin said. Underinvestment could translate into a lower number of wafer starts, causing system makers to miss time-to-market and next-generation requirements.
"Capital spending of 28% of sales was too high for the last couple of years," said analyst Bill McClean of IC Insights Inc., Scottsdale, Ariz. "But capital spending at 19% of sales is too low for 1999. This may be overcorrecting. Suppliers may fall behind the curve if the level is too low."
While the undercapacity issue could mean bad news for buyers, DRAM makers, hit particularly hard in recent quarters by severe price erosion, are looking forward to having the tables turned.
With fewer new fabs planned and bit demand continuing to rise, a shortage of DRAM chips looms on the horizon. Two analysts at ISS projected the supply-and-demand curve will balance out by the end of this year, with true undercapacity emerging early in 2000.
"The DRAM supply will tighten throughout 1999, and the imbalance between supply and demand will be resolved in the fourth quarter of this year," said analyst Hitoshi Shin of Merrill Lynch Japan Inc., Tokyo. "By 2000, the demand for DRAM will exceed the supply, and higher prices will be sustained."
Clark Fuhs, an analyst with Dataquest Inc., San Jose, agreed that a slight shortage in the memory market will begin next year, with undercapacity increasing through the end of 2001 and then returning to a supply-and-demand balance in mid-2002. This is primarily the result of reduced capital spending over the past year, resulting in fewer fab openings.
Fuhs noted that the industry could see as many as six DRAM fabs mothballed by the end of the year, including sites already shut down, such as Richardson, Texas-based TwinStar Semiconductor Inc., the Hitachi-Texas Instruments joint venture. Prime candidates for closure include sites owned by beleaguered Japanese semiconductor manufacturers and by the business to be formed by Hyundai's acquisition of LG Semicon's chip unit. These moves will contribute to the memory drought, even as increasing income drives capital spending north.
With equipment spending headed upward for the foreseeable future, Fuhs expects to see more fabs breaking ground this year and next, and overall semiconductor capacity swelling faster than the demand for memory bits. The result will be a potential return to overcapacity by the end of 2002.
In the meantime, DRAM manufacturers may be able to garner the higher profits that keep them in the business in the first place. "The DRAM industry generated profits of $62 billion during the last up cycle, from 1992 through 1996," Fuhs said. "Today they're losing about $5 billion per year, and we're not predicting a return to profitability anytime in 1999. But the higher prices we'll see in the fourth quarter of the year will stretch out and hold into the first half of 2000."
Generally, the average price of all semiconductor components has been climbing since July, according to IC Insights' McClean. In July, IC ASPs fell to slightly more than $1.70, but crept up to about $2.10 by year's end.
Chip oversupply typically occurs when there is a peak in capacity, so "a peak in capacity drives down ASPs," McClean said. "ASPs are now increasing, so, hopefully, capital spending won't be far behind."
Other industry observers, however, say the recent price increases and threat of undercapacity may be misinterpreted.
For example, factors such as the transition from 6- to 8-in. wafer fabs, and the reinstatement of additional manufacturing shifts, which may have been scaled back in a softer economy, are likely to add capacity in the coming months, said G. Dan Hutcheson, an analyst with VLSI Research Inc., San Jose.
"Those who say there may be undercapacity may not be taking wafer fab conversions and other factors into consideration," Hutcheson said. "Capacity is still there. There may have been an artificial increase in prices as these things occur. It's still too early to say what will happen with prices. Prices are one of the hardest things to predict."
Copyright ® 1999 CMP Media Inc.
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