Intel Upgrades Semi Equipment Stocks

| About: Intel Corporation (INTC)
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Intel (NASDAQ:INTC) reported earnings for Q4, showing a sequential and year-over-year decline in earnings per share tied to lackluster personal computer sales.

However, there was an important silver lining in the earnings call for those interested in semi equipment stocks such as Applied Materials (NASDAQ:AMAT).

As part of Intel's ongoing strategy to remain an early adopter of next generation technology, the company will ramp its capital spending budget from $11 billion in 2012 to $13 billion this year.

The 20% jump is significant for names like Applied Materials, which has been an Intel Preferred Quality Supplier for each of the past two years.

The move from 28 nanometer ("nm") to 20 nm has disappointed those hoping for bigger power savings and speed gains. As a result, some foundries are downplaying 20 nm in favor of 14 nm, which offers battery power savings of 40-60% from current 28 nm designs.

The race to 14 is driving the jump in Intel's capex.

Intel hopes to have 14 nm chips shipping to clients in 2014. This schedule would keep it ahead - barely- of competitors Taiwan Semi (NYSE:TSM), United Micro (NYSE:UMC), Global Foundries, Samsung (OTC:SSNLF) and I B M (NYSE:IBM).

Historically, semiconductor capex followed a predictable path. According to Moore's Law, every two years the number of integrated circuits on a chip doubles. As a result, capital spending has followed a similar 2 year cycle. Investments build out capacity, which becomes absorbed over the following 2 years, prompting re-investment in the next generation.

This 2 year cycle appears to be quickening in regard to the shift to 14 nm. In a nod to the "me-too" nature of the industry, Intel's move into 14 nm is ushering similar investment across the board.

In December, Samsung announced it had successfully taped out 14 nm designs, thanks to collaboration with Cadence Design (NASDAQ:CDNS), Mentor Graphics (NASDAQ:MENT) and Synopsis (NASDAQ:SNPS). The successful tape-out suggests Samsung's clients will be working on 14 nm designs over the coming two years. It also suggests Samsung, which has some of the deepest pockets in the business, will be boosting its capital spending this year and next.

Samsung's foundry business doubled last year, making the company the #3 global foundry operator. A lot of its strength has come thanks to its Apple (NASDAQ:AAPL) relationship, which could be at risk as Taiwan Semi actively courts Apple. In a bid to protect its Apple-share, Samsung has announced a $4 billion upgrade to its Austin Texas foundry in order to take it from 32 nm to 28 nm. A move to 14 nm finFETs could further boost Samsung's global share of Arm Holdings (NASDAQ:ARMH) designed chips.

Global Foundries and Taiwan Semi, afraid of being left behind, moved up their 14 nm finFET schedule too. In effect, this schedule change results in roughly a one year gap between 20 and 14 spending, breaking from the historical 2 year cycle.

Taiwan Semiconductor expects to invest $9 billion on 20 nm, 16 nm and 14 nm this year. Based on comments from customers, TSM expects 20 nm SoC volume will be higher than 28-nanometer at the same point in the development cycle. The increase to $9 billion represents growth of $700 million from 2012.

Building out a 300 mm fab isn't cheap.

It costs Intel and foundries as much as $4 billion to build a new fab. Intel's commitment of $2 billion for 14 nm this year is likely to be followed by a similar investment in 2014. The company should have 2 new 14 nm fabs fully ramped up by late 2014, with most of the capacity taken up by 2015.

Global Foundries 14 nm production will happen at its 300mm fab in Saratago NY. GloFo is spending $2 billion on a research facility this year with a completion date in 2014. The company may have announcements in 2013 regarding future 10 nm technologies too.

The investments are likely welcomed by customers like Qualcomm (NASDAQ:QCOM) who are eager to enjoy the benefits of 14 nm designs. The move from 40 nm to 28 nm reduced power consumption by 40% while increasing speed by 35%. However, the move from 28 nm to 20 nm only reduced power 20% while boosting speed 15%. Many think the comparatively meager gains in the shift to 20 nm is behind the faster adoption of 14 nm, which offers more attractive gains.

But, the push to 14 comes at a price, with designs becoming increasingly complex and requiring significantly more debugging and testing. This requires a much deeper collaboration between foundries, customers and testing companies including Teradyne (NYSE:TER).

This need for collaboration prompted both Intel and Taiwan Semi to invest in A S M L Holdings (NASDAQ:ASML). The investments give the foundries access to the latest extreme ultraviolet lithography ("EUV") technology. ASML announced this past summer it's acquiring Cymer, Inc. (NASDAQ:CYMI) in part to capture Cymer's EUV technology.

But, modern processes including 3D finFET involves more than just lithography. Hundreds of automated steps need to be performed by machines such as those made by Applied Materials. Those machines sell for $2-6 million apiece and are often customized, further boosting the price. Additionally, the automation software is provided by AMAT.

The growth in demand is good news for an industry that lagged last year.

Back in July, Applied Materials projected industry wide semi equipment sales of $30-35 billion, down from earlier projections of $32-35 billion. The lowered expectation provided cover for AMAT announcing a 9% cut in its workforce - a move expected to shave $150-190 million a year in costs.

Across players like AMAT, leaner expenses leveraged against the next wave of equipment demand should provide shareholder friendly operating margin upside. This suggests semi equipment shareholders may be rewarded over the next two years.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AMAT, CDNS, SNPS over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.