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Investment In Semiconductor Industry

Semiconductor Industry is composed of companies that are involved in designing, fabrication, assembly and testing of semiconductor devices. Semiconductor devices are electronic components that are used in the electrical circuits and form the building block of electronic systems such as computers, wireless and wire line communications, automobile electronics, consumer electronics, medical electronics, industrial equipment, etc. According to data published by Semiconductor Industry Association, worldwide semiconductor sales for FY 2012 were USD291.6 bn.

Semiconductor companies that are involved in all the processes of chip manufacturing i.e. designing, fabrication, and assembly & testing are called Integrated Device Manufacturers (IDMs). Some of the well known IDMs are Hitachi, IBM, Intel, Matsushita, Mitsubishi, Freescale, NEC, Philips, NXP, Samsung, STMicroelectronics, Texas Instruments, Toshiba, etc.

Fabless semiconductor companies are involved in only the designing and sales of semiconductor devices. They outsource fabrication and assembly & testing. This model has been particularly helpful for smaller companies, who otherwise could not compete due to high capital investment required in setting up a fabrication facility. Some of the large Fabless semiconductor companies operating today are AMD, Broadcom, Marvell, MediaTek, Nvidia, Qualcomm, etc.

Foundries operate a fabrication plant and manufacture semiconductor devices for others, without adding much to the design process. Earlier, all the companies in the industry followed an integrated business model and operated their own fabrication facilities using their own technology. However, economic efficiency demanded a move towards specialization and a large number of companies opted for a fabless model recognizing that the foundries could manufacture the chips at lower cost due to better utilization of facilities. Major foundries are TSMC, UMC, Globalfoundries, SMIC, etc.

The industry is highly cyclical mainly due to the cyclicality of demand in the end product markets. This cyclicality is significantly exacerbated by the capital intensive nature of the semiconductor industry and the time required for installing new capacity. This causes periods of high capacity utilization, when demand is robust, followed by periods of under utilization and accelerated price erosion, when new capacities are commissioned and demand growth slows.

After contraction in 2000-01, the industry witnessed a sustained period of growth till 2007 and then again had to face contraction in 2008-09. The semiconductor industry growth and GDP growth have witnessed a greater trend of correlation since 2002 and an expectation of recovery in global GDP growth going forward augurs well for growth expectations in semiconductor industry.

According to the semiconductor and packaging report by Pismark Partners, semiconductor market is expected to grow at a CAGR of 6.5% from 2011-16. Smartphone and feature phone sales are expect to grow at a CAGR of 10% and the volumes are expected to growth at a CAGR of 14% between 2011 and 2016. These will be the engine of growth for the industry. In addition, surging tablets sales will also add to the semiconductor device demand growth. Understanding and identifying changes in business cycles of semiconductor industry can prove to be very profitable. Post 2009, the valuations have remained low and we feel that with improvement in industry fundamentals, we may find good investment opportunities in the sector, especially in the high yield bond space. Wealth management advisors and portfolio mangers would do well to add segment leaders and benefit from tightening of yield in the corporate bond market.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.