Applied Materials' Conference Call Comments on Foundries Misleading (AMAT, SLAB)

Includes: AMAT, SLAB
by: William Trent, CFA

On yesterday’s earnings conference call, Applied Materials (NASDAQ:AMAT) CEO Michael Splinter said that foundry capacity is getting tight. While this certainly may be true, recent data points indicate a different picture. In the end, the comment may be right when applied narrowly but misleading as an indicator for overall semiconductor industry spending.

Before elaborating, allow us to briefly define a few of the terms, as we believe the CEO’s statements may, like another recent famous statement, depend on your definition of the word “is.” Or at least “foundry.” To start with, Applied Materials sells equipment used to make semiconductors at fabrication plants, or fabs. A foundry is a fab that is available on a contract basis to companies that do not have their own fab capacity. These companies, such as Silicon Laboratories (NASDAQ:SLAB), are said to have a fabless model.

So when Michael Splinter says foundry capacity is getting tight, he may not be saying that overall production capacity at all fabs is tight. Further, since the foundries are primarily based in Asia they do not show up in some of the economic data that contradicts the overall point. However, the foundries are an important part of the business. UBS estimated that foundries accounted for nearly 30 per cent of total industry capital spending in 2004.

Now let’s compare the tight capacity comment to recent economic data. The obvious place to start is Tuesday's Capacity Utilization report. The latest reading shows capacity utilization at just over 70 per cent. It has been steadily declining since late 2004, when it was above 83 per cent. It is far from the bubble peak of 98 per cent.

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