The foundry business is coming back faster than expected
"But demand is changing so fast that it's nearly impossible to track what's going on; one foundry executive calls it "a case of market whiplash"
By James B. Brinton
Forecasting market demand never is an easy task. But the job was never harder than it is now in the pure-play foundry business. This rapidly growing part of the chip market is now emerging much faster than expected from the worst slump in its short history. Demand for these services is changing so fast that market watchers are now finding it nearly impossible to track either the degree or the kinds of changes that are influencing this sector. It's the sort of change that burns out managers and can't even be quantified by market analysts.
As late as two months ago, nearly everyone was talking about a foundry capacity glut. But that glut is now being wiped out by an unexpected surge in demand and big changes in demand patterns. This upswing is coming hard on the heels of a severe business contraction that had wiped out the bulk of capital spending plans.
Foundry capacity now appears roughly equal to demand, but forecasting either one is proving to be extremely difficult. To the experts, the situation is both confused and contradictory, holding out both the possibility of a capacity shortfall and the hope of unprecedented growth.
The good news is that the plunge in demand which forced some foundries to run at below 50% utilization rates last year is history. There's no doubt about that. "Last year was bad," confirms one bruised industry executive. "At one point, we were at 48% utilization. Thank God the market's back."
Foundry utilization rates last year averaged less than 70% with overcapacity exceeding 40% at some companies, according to industry analyst Jim Hines at Dataquest. But the picture began to change in the fourth quarter, he says. Now the figures seem to rise almost hourly.
Hines reckons that industry-wide overcapacity in the first quarter dropped to an average of about 20%, and that by the middle of the second quarter demand should be running far more than foundry capacity. The turnaround has been almost instantaneous, as these things go. One bemused foundry industry executive calls it "a case of market whiplash."
Foundry customers are noticing it too. "Wafer demand clearly has shot up in the last three months," notes Dennis Segers, senior vice president of FPGA development at Xilinx Inc., the San Jose-based programmable logic supplier. "Two factors appear to be at work," he says. "A recovery in the overall semiconductor market, and the success of pure-play foundries . . . in attracting business from [the integrated device manufacturers]."
Whatever happened, "it happened fast!" declares Jim Ballingall, vice president of worldwide marketing for the UMC Group (USA) in Sunnyvale, Calif. "We got the expected orders for the Christmas and Chinese New Year's seasons, and frankly, expected a fall off in demand afterward. But instead," he says, "demand stayed high."
Now UMC is booked solidly through mid-June, and the upward trend is expected to continue, Ballingall predicts. As late as last January, UMC was projecting that it would turn out about 2 million 8-inch wafers in 2000. Now, due to the turnaround, its model predicts that between 2.3- and 2.5-million wafers will be produced at the Taiwan company that year.
The picture is much the same at Chartered Semiconductor Manufacturing Ltd., in Singapore. "We're running near capacity now, and we expect to be at or near capacity for the foreseeable future," says Kevin Meyer, vice president for worldwide marketing.
"We saw the first signs of the turnaround [late in the third quarter of 1998]," claims Meyer. "Because our customer base consists mostly of telecom companies [and a 'leading-indicator' market], our business probably picked up earlier than [it did for] most others. And it picked up fast," he adds.
In fact, orders turned up so fast that Chartered is increasing its production capacity. So are UMC and Taiwan Semiconductor Manufacturing Co. Ltd. (TSMC), the other two of the "big three" foundries.
"The business has changed dramatically since January first," confirms Magnus Ryde, president of TSMC USA in Sunnyvale, Calif. And he's happy about it. "We went through 1998 at a utilization rate of about 73%, and though we were profitable, that's not a place you want to be."
Like the other big foundries, TSMC's business kept increasing in January instead of going into the seasonal slump that usually follows the holiday season. In fact, by February, orders were rising so fast that they were running was well beyond TSMC's internal forecasts, Ryde notes.
Today, TSMC's fabs are running at utilization rates that average in the "high 90% range," Ryde says. In other words, the foundry leader is close to capacity, with only a little flexibility still remaining.
Capacity is becoming an issue. TSMC originally planned to produce the equivalent of about 1.6 million 8-inch wafers in 1999. Now, says Ryde, "we will surely exceed 1.8 million, and may top 1.9 million." The situation changed very quickly. "We thought as late as mid-January that we had the scheduled capacity necessary for 1999," he notes, "but since then we've enlarged our expansion plans significantly."
It's not only the big three that are profiting - this tide is raising all boats. Smaller foundries, such as Great Britain's Newport Wafer Fab Ltd. and Israel's Tower Semiconductor Ltd., say they are pulling in the new business and bringing idled capacity back on line.
"Business is good," says Steve Della Rocchetta, Newport executive vice president in its San Jose office. "In our case, it's based on orders from several American and European IDMs. Suddenly," he says, "we found ourselves doing whole product lines for these companies. As a result, our utilization is ramping upward at 6% to 10% per week. Projecting that [out], we expect full utilization in several months."
The question that's now on the minds of industry managers is just the opposite of what was worrying them last fall. With every pure-play foundry becoming an optimist overnight, and with all of them running at or heading toward full utilization, they now wonder whether they are heading instead for a capacity shortfall.
Opinions are mixed, of course, and the statistics that usually buttress such projections are moving targets, according to key industry analysts such as Joanne Itow of Semico Research in Phoenix. She is now convinced that the claims of fab executives that they are running at high capacities are accurate.
"We assembled our last capacity/demand projection in November," Itow says, "and since then things have moved so fast and so far that I no longer trust it."
But even that 1998 report showed the possibility of an early wafer shortfall. It all depended on how much of the IDMs' production would move to the foundry sector. Itow's November projection indicated a shortfall could hit foundries by January 2000 if the big integrated chip makers placed 10% of their production with foundries this year.
That production shortfall, however, could arrive a lot sooner, even though every member of the foundry community has begun adding capacity. "I think there is reserve capacity in the industry," allows Itow, "but capital investment over the past year was constrained. Even though some new plant is under construction and some cleanroom space already exists, it's a question as to how soon this capacity can become available."
There's the rub. Dataquest's Hines agrees that is hard to judge the present ratio of demand to capacity. Like Itow, he finds it difficult to make projections now because of the rapid pace at which the market is changing. But his hunch is that the foundry segment - with enough additional capacity brought on line - could be heading for a period of approximate supply-demand balance.
Maybe. Taiwan's chip industry, most of which is pure-play foundries, was expected to pour $4.5 billion into capital investment this year. But that estimate came from a January forecast and the real figure is probably much higher now, observers say.
Foundry managers also are saying all the right things now about adding capacity. Chartered's Meyer, for example, says that three of his company's five existing fabs, which includes joint venture fabs with Lucent Technologies Inc. and Hewlett-Packard Co., are being "aggressively ramped up today."
The Singapore foundry also is able to add capacity much faster. In recent years, it has been building plant and "facilitizing" only about half of the potential capacity, eliminating the time it would take to build clean-rooms from the ground up. Chartered's "semi-equipped" plant is running at "about 600,000 eight-inch wafers per year today," Meyer says. "During the coming three years, we will be at least doubling that." That would give Chartered a capacity of something like 1.2- to 1.3-million wafers by about 2001.
TSMC also is adding a lot of capacity fast. It has a fab under construction in Singapore (with Royal Philips Electronics NV as a partner) that's scheduled to come on line at the end of 2000 with a capacity of 40,000 eight-inch wafers per month. Plans for another new plant, Fab 6 in Taiwan, have been accelerated by four months and should now be coming on line by the fourth quarter, reaching full capacity of 40,000 wafers monthly by mid-2000.
The capacity of TSMC's Fab 5 in Taiwan is being roughly doubled to 28,500 wafers a month and is expected to be running at that capacity before the end of this year. Its Fab 4 in Taiwan, which now has cleanroom space available, is already producing about 32,000 eight-inch wafers a month but is not currently being ramped higher, according to the company.
TSMC's Wafertek plant in Oregon is being ramped up now as well and should be turning out 20,000 wafers a month by the end of 1999.
UMC is also adding new plant. It took advantage of the lull in wafer demand to acquire fabs at low prices last year, which ended up improving its competitive position and capacity without expanding industry capacity. When Taiwan's Holtek Microelectronics Corp. went fabless, UMC bought its fab. It also acquired Japan's Nippon Foundry Inc. from Nippon Steel.
In late April, UMC bought Oak Technology Inc.'s 9.3% stake in United Integrated Circuit Corp. (UICC) for $51.2 million. Last October, ESS Technology Inc. sold its shares to UMC in the joint venture fab, which was originally set up between the Taiwan foundry and seven U.S. chip companies.
The Taiwan foundry also is building new fabs. Under construction in Taiwan is United Silicon Inc.'s 8-inch wafer fab and its Fab 5. "We built the shell last year," notes Ballingall, "and we're moving in the production equipment now." If all goes well, Fab 5 could be producing 40,000 eight-inch wafers a month by November, he says.
The smaller foundries also are beefing up their capacity. Even though it was having financial problems last year, Newport was able to finish its Fab 3, an 8-inch, 0.35-micron facility in Newport, Wales.
With all this new foundry capacity being added now, the orders are flooding into the semiconductor equipment manufacturers.
"March was our best sales month in the past 12," exudes Jack Ghiselli, president of GWAssociates Inc., a Sunnyvale, Calif., company which supplies much of the factory automation software to the foundry industry.
But the danger now is that if their order books suddenly fill up, equipment vendors may not be able to supply production gear as quickly as the foundries want it. There are sectors of the capital-equipment industry that are unable to turn on a dime, reminds one executive, and lithography is one of them.
A big reason is that those vendors are going to have to crank up their own production lines. "Over the past couple of years, for example, Nikon was forced to cut everything to the bone," notes one chip executive. "They cut annual capacity from 2,000 units to 800."
Another major lithography house has cut capacity by two-thirds over the past 24 months, adds this executive. "Their ability to produce is way down. So is their manpower, and their supply chain isn't in good shape either. You can't just turn these companies back on by flipping a switch."
Another industry observer agrees that while fab shells may already be built, there may be less production gear available to fill them than some chip executives are counting on. "Lithography could be a bottleneck," she says. "Lead times on lenses are 12 to 24 months, so don't expect overnight delivery."
With all these imponderables, it makes it tough for anyone to decide whether the additional capacity - if it materializes - will be enough to meet the growing demand expected over the next year or two. According managers closest to the problem, such as TSMC's Ryde, the answer is that "nobody knows yet." It's just too early to tell.
In Ryde's opinion, the foundry business is in its earliest stage of the recovery. And the metrics are changing so quickly now that all the industry and analysts can do now is monitor the situation closely until the trends become clearer. To do that, they will have to get a better handle on what's driving the recovery. It appears they are still gathering data, rather than forming a consensus. Confusing the picture even more is that product, customer, and technology mixes vary from foundry to foundry, shaping each company's view a little differently.
Demand patterns are still unclear. One of the few certainties is that demand seems to be broad-based. Wafer orders are coming from across the board - from the fabless houses to the IDMs and the DRAM makers.
As far as markets are concerned, UMC's Ballingall figures that the wafer-demand drivers include the PC chip market, which is proving to be stronger than anticipated. "Everyone expected demand from the graphics companies to contract," he says. "Instead, demand is solid and their prices have firmed up." And demand for consumer-product ICs and networking semiconductors is also strong at UMC, Ballingall adds. One hot category now is in low-power parts for portable communications.
What's paying off at Tower, it seems, is the Israeli company's strategy of stressing embedded-memory-intensive technology, as well as its CMOS image sensor technology. Business in both areas is showing "significant increases in demand," Paraskevopoulos notes.
Another area of uncertainty is the impact of IDMs as they move to foundries for more of their manufacturing needs. No one seems equipped - or willing - to estimate just how much foundry capacity they are soaking up at present. The consensus now is that the impact on the foundry business will be a major one if the big IDMs make good on their highly publicized intentions - Motorola's plan, for example, to move half of its IC production from its own lines to outside foundries in four years.
Memory is turning into a strong growth market for foundries. Dataquest's Hines says major foundries such as TSMC and UMC already are doing "a fair amount of DRAM work." Foundries like the DRAM business because of its cookie cutter nature, large volumes, and because DRAMs usually require their highest-resolution production equipment. At this point, Hines figures, DRAMs may be eating up 8% to 10% of total foundry capacity.
The possibility that demand will exceed foundry capacity sooner than many people expected isn't worrying some chip executives. Mike Hackworth, chairman of Cirrus Logic Inc., believes there is sufficient latent capacity in the industry to permit the foundry industry to raise its capacity by two to two-and-a-half times between now and mid-2000. Some of this would come from new foundries being built, but mostly reflects the addition of production gear to existing fab shells.
In fact, Hackworth is so confident of this latent capacity that his Fremont, Calif., company is now renegotiating its joint-venture fab agreements with IBM Corp. and Lucent in an attempt to move closer to a pure fabless model. Cirrus wants to become more of a customer than a partner in these two fabs.
Xilinx Corp. managers also don't seem worried, but for different reasons. "While wafer production might become a problem for some, it won't be for Xilinx," says Segers. "Xilinx has long-term relationships and substantial equity investments with our foundry partners to lock in capacity beyond our immediate needs."
Then there are folks like Goodloe Suttler, marketing vice president for Analog Devices Inc., who doesn't see any shortage of foundry capacity materializing yet. His Norwood, Mass., company does most of its foundry business with TSMC. "I'm not that sure that fabs are running in the 90% range yet," he notes. "And I don't see the price or the lead-time pressure that usually goes with that. There's a little, but not an amount consistent with 90% utilization rates."
Those chip companies with the most at stake in the event of a capacity shortfall, of course, would be the fabless firms - no group is more dependent on foundries. But foundries managers are all quick to describe the fabless firms as their market base and that their interests would be given priority if overall demand ever exceeded capacity.
Perhaps that's why the fabless companies don't seem concerned now with any possible capacity shortage.
"Fabless firms aren't necessarily worried, but they want to be sure that foundry capacity is a recognized issue," comments David Angel, chairman of the Fabless Semiconductor Association. "We know that capacity crunches can take place, and hopefully, we have some time to work the system to make sure that we avoid such a situation."
"Communication is very important at times like these," adds Jodi Shelton, the FSA's executive director, based in Dallas. "Chip companies can't always predict their production needs any more accurately than the foundries can predict demand;" she says. This was certainly borne out by the events of the past three months.
To get around this problem, the fabless firms are following conservative strategies. "Some chip companies over- or under-order; some foundries over- or under-expand," Shelton says. "Hopefully, if we can be more open and accurate about capacity, demand, and timing, we can avoid a shortfall."
That may prove to be a difficult strategy to carry out. Even the FSA acknowledges it.
"Nobody really knows what the probabilities are now for a wafer-capacity shortfall," comments FSA chairman Angel. Not only is the basic situation fluid, but "many companies have been reevaluating their business models and market strategies over the past two years," he points out. "You don't know where some companies are going to be coming from in the future and that multiplies the uncertainties."
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