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Investing Opportunities in the Semiconductor Industry

China, Stocks, US

Written by:

Zhi Rong Tan

Semiconductors are still in short supply throughout the world. Many firms, including Apple, have stated that their forecast earnings are likely to be tamped down due to the continued chip scarcity.

The world today is pretty much powered by semiconductors. We wouldn’t be able to function without them. Hence, the demand for semiconductors is likely to rise and as such, many investors may see the current scarcity as an opportunity to invest in semiconductor companies and ride on their rise.

That being said, the semiconductor supply chain comprises a wide range of companies, each involved in various stages to produce the final chip.

You may be familiar with Taiwan Semiconductor Company (TSMC), a reputable foundry in the semiconductor industry. However, did you know that it does not manufacture semiconductors from start to finish? Instead, it relies on various partners such as Applied Materials (AMAT) for certain processes.

In this article, we’ll look at some of the companies involved in each step of the manufacturing process, to find out which segment is the best and how you can invest in the semiconductor industry, should you wish to.

First up, let’s look at some of their Chinese counterparts which could make a good investment opportunity now.

Why China?

If you read my earlier post on the Semiconductor Shortage, you would know that China has long trailed behind many other countries in terms of semiconductor technology and has historically relied on imports to supply its semiconductor chip demand.

Currently, China’s largest chipmaker, Semiconductor Manufacturing International Corporation (SMIC), can only produce 14-nanometer devices, lagging well behind its competitors. Foundries such as TSMC have already begun producing 5-nanometer chips (the smaller, the better).

While China may continue to rely on its trading partner, the situation has shifted in recent years.

As tensions between the US and China escalate, the US has imposed a slew of restrictions on China’s major technology firms, stifling their growth. Many Chinese IT companies are unable to obtain semiconductors from US corporations as a result of these restrictions. At the same time, Chinese companies have been cut off from their American suppliers and technology, which many global chipmakers rely on for software and manufacturing machines.

Because semiconductor chips are so important to China, the restrictions have encouraged them to focus on improving their capabilities in this area in order to lessen their dependency on other countries.

The chart below gives us a perspective of how important this industry is to China. Between 1995 to 2019, China’s shares of total world imports of semiconductors grew dramatically from 1% to 23%.

Source: piie.com

Not known to many, China is also a major exporter of semiconductors. As of 2019, its semiconductor exports makes up 20% of the world’s semiconductor exports. However, what this data does not reveal is the disparity in semiconductor imports and exports from China.

While China imports cutting-edge semiconductors for smartphones, telecommunications equipment, and other electronic devices, the semiconductors it exports are typically lower-end and more primitive than its competitors’.

Source: piie.com

As a result, we can see how critical it is for China to have a reliable source of cutting-edge semiconductors, otherwise, its economy will suffer. The sour relationship with the United States had exacerbated this, and China could be moving closer to self-sufficiency.

China has emphasised its long-term objective of being self-sufficient in semiconductor chip production as part of the Made in China 2025 agenda. China’s 14th Five-Year Plan, which was adopted in March 2021, reemphasised the importance of converting itself into a self-sufficient technology and manufacturing powerhouse.

R&D investment will increase by more than 7% per year from 2021 to 2025, and more favourable tax policies will be enacted to aid local semiconductor companies.

All of this could result in massive growth for China’s semiconductor industry, and investors interested in participating in this boom should consider buying Chinese semiconductor companies.

How does the Semiconductor Industry work?

The modern global semiconductor industry is generally divided into two models.

The first is a group of companies known as the Integrated Device Manufacturers (IDM) which designs, produces and sells their own chips. Intel is a well-known example. However, this business model may not be working as effectively as before and could be one of the reasons Intel is losing ground to its competitors. As a result, Intel has declared that it will outsource some of its manufacturing to fabless foundries.

The second model is the fabless foundry model which companies like Nvidia run on. They do not own nor run their own semiconductor foundries. Instead, they focus on designing semiconductors and have their designs manufactured by foundries like TSMC and SMIC.

In general, the whole semiconductor process can be breakdown into various stages, as shown below.

Source: Peterson Institute for International Economics

Semiconductor precursors companies (aka Inputs)

Before we start producing any semiconductors, we need the raw materials, the machines and also the software to tell the machines what to do. These are known as the Inputs and can be categorised into three groups:

  1. Electronic design automation
  2. Manufacturing Equipment
  3. Chemical & Materials

1) Electronic design automation (EDA)

Electronic design automation (EDA) firms offer sophisticated software and services to assist in the design of semiconductors.

These EDA tools are required to develop competitive advanced semiconductors with billions of transistors in a single chip.

2) Manufacturing Equipment

These firms produce semiconductors that necessitates incredibly sophisticated equipment.

Applied Materials, Lam Research, and KLA-Tencor are based in the United States and currently control more than 40% of the global market.

ASML and Tokyo Eletron account for another 30% of the market. This figure may appear to be quite high, but it may be understated because various firms, despite creating manufacturing equipment, do not produce the same equipment.

For instance, lithography equipment, which costs more than $120 million per machine, is currently manufactured by ASML, which controls 75% of the global market.

Lam Research Corporation (NASDAQ: LRCX)

Lam Research is a leading manufacturer of semiconductor equipment for the semiconductor industry worldwide. Thin-film deposition, plasma etch, photoresist strip, and wafer cleaning are some of the Company’s offerings.

  • Revenue: US$14.6 billion
  • Net Profit: US$3.9 billion
  • Market Cap: US$86.79 billion
  • P/E ratio: 22.63
  • Dividend yield 0.85%

Advanced Micro Fabrication Equipment (SHA: 688012)

Advanced Microfabrication Equipment (AMEC) is a global semiconductor microfabrication equipment firm with headquarters in China. AMEC specialises in equipment for developing and manufacturing micro and nanoscale VLSIs, focusing on chemical vapour deposition and plasma etching. The Company’s primary markets are mainland China and Taiwan.

  • Revenue: US$351 million
  • Net profits: US$75 million
  • Market share: US$17.14 billion
  • P/E ratio: 164
  • Dividend yield: NIL

3) Materials

Semiconductor circuits demand a wide range of materials that are particularly unique to their requirements. For example, the polysilicon used to create the silicon ingots that are then sliced into wafers must have a purity level 1,000 times greater than that necessary for solar energy panels.

Integrated Device Manufacturer (IDM)

IDMs are firms that have vertically integrated the majority of the semiconductor manufacturing process. These firms design, manufacture, test, and package their chips entirely in-house, with no outside help.

IDMs account for a large number of semiconductor sales presently. But in recent years, the emergence of fabless foundries has gained popularity, particularly in light of AMD’s success as a chip designer and TSMC’s pure foundry play.

Intel Corporation (NASDAQ: INTC)

Intel is an integrated device manufacturer that designs and manufactures its own semiconductors. While it is still one of the largest semiconductor companies by revenue, it has lagged behind TSMC which is now producing much more advanced chips.

  • Revenue: US$77.61 billion
  • Net Profit: US$18.5 billion
  • Market Cap: US$219.6 billion
  • P/E ratio 12.04
  • Dividend Yield 2.57%

Semiconductors designers

We have companies that specialise in the design of semiconductor chips. It’s not easy to design a chip that powers our electronic devices, such as mobile phones. In fact, it takes a team of hundreds of engineers several years to complete. As a result, we have companies that focus solely on design and outsource manufacturing to another firm.

Nvidia Corporation (NASDAQ: NVDA)

Nvidia is well recognised for its line of consumer and high-end visual graphics cards, which can be found in many PCs. GPUs are critical for computer gamers, digital artists, and people who engage with computer-aided designs like AutoCad.

  • Revenue: US$19.3 billion
  • Net Income: US$5.3 billion
  • Market Cap: US$490.90 billion
  • P/E ratio: 93.39
  • Dividend yield 0.081%

GigaDevice Semiconductor Beijing Inc (SHA: 603986)

GigaDevice is a prominent fabless company specialising in advanced memory technologies and IC solutions, was founded in 2005. The Company manufactures a variety of high-performance Flash Memory and 32-bit general-purpose MCUs. It is currently ranked third in the world in the SPI NOR Flash Memory segment, with over 1 billion units sold annually.

  • Total revenue: US$ 690million
  • Total profit: US$135 million
  • Market cap: US$19 billion
  • P/E Ratio: 136.34
  • Dividend yield: 0.22%

Foundries

Foundries are where semiconductors design companies send their designs to. These facilities then ‘print’ the design onto silicon wafers which will be used in many of our electronic devices.

This process is very complex, especially as the nodes get smaller, the process can involve up to 1000 steps. The condition for producing these wafers is also highly controlled as a slight change in external conditions like the introduction of ambient air could affect the whole production.

Taiwan Semiconductor Manufacturing Company (NYSE: TSM)

Taiwan Semiconductor Manufacturing Company is one of the world’s largest semiconductor foundries, specialising solely in the production of wafers for its customers. As a result of its technological capability, many semiconductor companies outsource the manufacturing of their components to Taiwan Semiconductor.

  • Revenue: US$52 billion
  • Net Income: US$21.6 billion
  • Market Cap: US$544.44 billion
  • P/E Ratio: 30.23
  • Dividend yield: 1.58%

Semiconductor Manufacturing International Corporation (HKG:0981)

SMIC is the largest semiconductor foundry in mainland China and is partially controlled by the Chinese government. It is a foundry, like TSMC, that makes wafers for customers such as Qualcomm, Broadcom, and Texas Instruments. At the point of writing, SMIC is still lagging behind TSMC in terms of its semiconductor technology.

  • Revenue: US$4 billion
  • Net income US$0.8 billion
  • Market cap US$38 billion
  • P/E ratio: 18.74
  • Dividend yield: NIL

Assembly, testing and packaging

In the final stages of the semiconductor manufacture process, wafers must be tested, transformed into ready-to-use chips, and packaged after the foundry or IDM creates them. Such companies are commonly known as “Outsourced Assembly and Test (OSAT)” and are primarily based in Asia.

ASE Technology Holding (NYSE: ASX)

Advanced Semiconductor Engineering Technology, established in Taiwan, offers semiconductor assembly, packaging, and testing services.

  • Revenue: US$18.6 billion
  • Net Income: US$1.27 billion
  • Market Cap: US$19.88 billion
  • P/E ratio: 17.16
  • Dividend yield: 1.48%

JCET Group Co Ltd (SHA:600584)

JCET Group Co Ltd is a Chinese firm specialising in the testing and distribution of integrated circuits and discrete devices, as well as chip design and manufacturing.

  • Net revenue: US$4 billion
  • Net profit: US$201 million
  • Market shares: 10.18 billion
  • P/E ratio: 38.14
  • Dividend yield: 0.13%

How long will it take for China to grow?

The two heavyweights in today’s semiconductor industry rose from a shortage of semiconductors created by a trade dispute between the United States and Japan.

Long story short, the US was upset that Japan was importing so many semiconductors into the US while its domestic semiconductor manufacturers were experiencing disappointing sales. As a result, tariffs were implemented, raising the price and decreasing the supplies of Semiconductors.

Around the 1960s, South Korea and Taiwan took advantage of this opportunity and invested millions of dollars in semiconductor companies. Taiwan and South Korea currently have a sizable share of the semiconductor market, particularly in advanced semiconductor chips.

Source: piie.com

Why did I share this information with you?

Well, I’d like to demonstrate that, while China’s Semiconductor Industry is not as advanced as its peers, there is a chance it could catch up if the Chinese government is ready to spend extensively on it (and it is what they are doing).

In addition, there is a current shortage of semiconductors and an ever-increasing demand for them, which I believe could drive the advancement of these companies even more.

Conclusion

The semiconductors industry are here to stay, and they will continue to be in demand as the world becomes increasingly digitalized. The question is whether investors should look into the Semiconductor industry right now. You should make this decision after assessing the various risks and rewards, discussed in the preceding article on Semiconductor Chips Shortage.

If you are interested, you can do further research in the different semiconductor companies that are involved in each step of the production line. The table above by Peterson Institute for International Economics has many companies which you can research on.

Lastly, if you are interested in learning more about the semiconductor industry, do check out these 2 research papers that I found extremely helpful when writing this article:

You can also consider semiconductor ETFs to bet on the whole industry, instead of any individual companies.

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