Taiwan semiconductor industry update / Closer Cross-Strait ties benefiting Taiwan’s semiconductor industry

[The below material is taken from the forthcoming PricewaterhouseCoopers report, “China's impact on the semiconductor industry: 2011 update”, which will be published later this year.]

Taiwan’s semiconductor industry enjoyed a good 2010 but growing clouds surrounding the strength of the global economic recovery signal stormy weather ahead. Despite this uncertainty, Taiwan’s semiconductor companies are well-positioned to take advantage of growth in the still-buoyant China market, which has become an increasingly important production and sales location for Taiwanese EMS and ODM companies and their supply chains. Indeed, Taiwan’s growing economic relationship with China and the progressive easing of cross-Strait investment restrictions will have a significant influence on the direction of the semiconductor industry in the Greater China region.

Shifting industry outlook on global uncertainty

Taiwan’s IC industry revenues as a whole (including design, manufacturing, assembly and testing) jumped 37.3% to a record NT$1,716 billion (US$58.9 billion) in 2010, according to Taiwan Semiconductor Industry Association (TSIA) statistics, benefiting from the global economic resurgence and China’s ever-growing consumption of semiconductors. The initially positive outlook for Taiwan’s semiconductor industry in 2011 has dimmed, however, on concerns of slower global growth. The latest TSIA forecasts made in August 2011 projected an 8.3% decrease in IC industry revenues for the year, in stark contrast to the 8.7% increase predicted seven months earlier.

For the time being, Taiwan’s domination of the global chip foundry and semiconductor assembly and testing sectors is assured. Taiwan Semiconductor Manufacturing Co. (TSMC) and United Microelectronics Corp. (UMC) together account for about two-thirds of the total worldwide pure-play IC foundry market, while Advanced Semiconductor Engineering Inc. (ASE) is the world's largest provider of contract semiconductor assembly and testing services. However, IC design start-up companies in China are increasingly challenging Taiwan’s chip design industry, which is the second largest in the world behind the United States. In addition, Taiwan’s DRAM manufacturing industry, which once accounted for about a fifth of the world’s production of PC memory chips, is progressively shrinking as it struggles to keep up with larger global rivals.

Mixed China fortunes for Taiwan’s contract foundries

TSMC and UMC, the world’s two largest contract chipmakers, started to report weaker demand from the second quarter of 2011, as clients cut orders to reduce inventory on concerns about the global economic outlook. In response, TSMC cut its 2011 capital spending target from US$7.8 billion to US$7.4 billion, while UMC maintained its expenditure programme for the year at US$1.8 billion. Both companies’ capex plans remain aggressive to handle increased outsourcing from IDMs of their chip production, as well as fend off new competition from GlobalFoundries Inc. At the same time, the companies are seeing continued strong demand for lower-priced chips from China.

TSMC stepped up its presence in China after the Taiwan government relaxed restrictions on China-bound high-tech investments in February 2010. Four months later, TSMC received approval to take up the 8% stake in Shanghai-based Semiconductor Manufacturing International Corp. that it was awarded as part of a legal settlement over a trade secrets dispute. In September 2010, it got the go-ahead to upgrade the process technology at its 8-inch wafer fab in Shanghai to 0.13 micron from 0.18 micron. TSMC also reportedly plans to expand production capacity at its Shanghai plant. As for UMC, it terminated its proposed full merger with Suzhou-based chipmaker Hejian Technology (Suzhou) Co. Ltd. in November 2010 after it was rejected by Taiwan’s financial regulator, partly because the way UMC intended to finance the transaction ran afoul of the rules. In March 2011, UMC announced a revised plan to acquire an additional stake of up to 30% in Hejian on top of its existing 15% holding, which was awaiting government approval at the time of writing.

Copper wire-bonding boost for IC assemblers

Despite rising caution among global chipmakers, Taiwan’s leading providers of IC assembly and testing services have maintained their capital expenditure plans for 2011. ASE will spend most of its US$750 million budget on boosting copper wire-bonding, high-end flip-chip and discrete-device packaging capacities at its factories in Taiwan and China. IC assembly sales generated from copper wire bonding increased substantially in 2011, as more clients have accelerated the migration process from gold bonding to keep up with thriving demand from tablet-PC, smartphone, and smart-TV makers. ASE has also vigorously boosted its production capacities in China as part of its plan to relocate low-end production to the mainland while retaining high-end production in Taiwan.

Taiwan's IC designers face increasing competition in China

MediaTek Inc. and other Taiwanese IC design houses continue to see robust demand for their various chipset solutions. However, they face growing competition from their Chinese counterparts, most notably Shanghai-based Spreadtrum Communications, in the low-end mobile-phone market. The threat to Taiwan’s IC design companies will only grow stronger as the Beijing government has adopted policies in its 12th five-year economic development plan (2011-2015), to accelerate the expansion of China’s IC design industry in favour of home-grown companies. That said, Taiwanese IC designers can still expect to benefit from China’s push for triple network convergence—the Internet, telecom and TV broadcasting networks—given their strength in customized solutions.

MediaTek, the biggest supplier of chips in China, has seen its earnings decline since the second quarter of 2010 because of intensifying competition in its core feature-phone chip market and its slow progress in designing chips for high-end smartphones. In response, the company has stepped up its efforts to diversify its product portfolio, primarily through acquisitions—including a US$598 million deal in March 2011 for smaller Taiwan-based rival Ralink Technology—that aim to build up MediaTek’s technology capabilities in communications and digital home entertainment.

Taiwan’s DRAM chipmakers on the ropes again

The DRAM recovery in 2010 proved short-lived for Taiwan’s chipmakers, as slowing demand, bloated inventory levels and falling prices again threaten the sector. With only one year of respite since the last slump, most local manufacturers’ financial status and cash positions have not recovered. Even worse is that deep-pocketed Samsung Electronics, the biggest DRAM maker in the world, is investing heavily to increase its market share, which in turn has pushed DRAM prices down further on a renewed supply glut. The sharp fall in prices has had the greatest impact on Taiwan’s DRAM manufacturers, which are among the least profitable companies in the business owing to their small scale and lagging production technology. A major industry shake-up is coming.

Several chipmakers have already taken action to reduce their over-dependence on PC DRAM, a highly commoditised product that is the best-selling type of DRAM chip. Winbond Electronics Corp., Powerchip Semiconductor Corp. and ProMOS Technologies Inc. have all largely left the PC DRAM market to become either contract manufacturers for Japan’s Elpida Memory Inc. or manufacturers of other, niche DRAM products. Taiwan’s two other DRAM companies, Nanya Technology Corp. and Inotera Memories Inc. (a joint venture between Nanya and America’s Micron Technology Inc.), also plan to diversify their volatile business by selling chips for mobile devices and servers, which require more customisation and higher qualifications but fetch higher prices.

Elpida and Micron Technology have formed key partnerships with Taiwan’s DRAM companies with the aim of taking stakes in them and boosting market share. In February 2011, Elpida, the world’s third-largest memory chipmaker, cross-listed on Taiwan’s stock market through a Taiwan Depositary Receipts issue, which it hopes will help deepen its alliances with local DRAM makers. Elpida CEO Yukio Sakamoto said at the time that while Taiwan’s chipmakers do not favour integration, they could still work together on different product lines. Elpida remains interested in buying a stake in ProMOS, which, facing imminent default again, filed a radical restructuring plan in July 2011 that it hopes will solicit support from its creditors and a future strategic partner.

As they ride out the latest crisis, Taiwan’s DRAM manufacturers will have only themselves to count on—the government having ruled out throwing them a life raft, as it did two years ago. “The government will not inject any capital [into any company],” Minister of Economic Affairs Yen-Hsiang Shih said after ProMOS announced its restructuring plan. This was a u-turn by the government after its previous efforts to consolidate Taiwan’s memory chipmakers came to nothing. Its original plan to revamp the industry by building a stronger DRAM entity—Taiwan Memory Co.—was scrapped in March 2010 following repeated opposition from lawmakers.

Taiwan pushing new industry initiatives

Meanwhile, the Taiwan government is developing initiatives in conjunction with the cabinet-level National Science Council (NSC) to boost growth in the semiconductor industry. In January 2011, the NSC kicked off a five-year National Program for Intelligent Electronics which will see the government inject over US$400 million into the domestic IC design sector. The program aims to develop integration technologies and applications for Taiwan’s strategic priority targets, including medical services, green energy equipment, vehicle telematics, information communication technology and consumer electronics. The NSC estimates the program will help grow the output of Taiwan’s IC design sector from about US$15 billion in 2010 to around US$22 billion in 2015.

Also, in March 2011, Taiwan’s National Chip Implementation Center, which promotes IC and system design technology, announced a new method of fabricating multi-chip systems that can cut development time by two-thirds and costs by half. The new technology stacks chip modules with different functions on top of each other, thereby enabling a higher density of electronic components on a circuit board, which could lead—among other things—to smaller mobile devices. TSMC Chairman Morris Chang has called the new technology, dubbed “MorPACK”, a paradigm shift.

More positive cross-Strait developments

The Greater China semiconductor industry received a fillip in March 2011 when the Taiwan government opened the door for the first time to investment from China in sensitive high-tech industries. The new rules allow Chinese investors to take investment stakes of up to 10% in Taiwan’s technology companies, including semiconductor and flat-panel manufacturers, and up to 50% in new technology-sector joint ventures. The new rules give Chinese investors access to some of Taiwan’s most globally competitive companies, including semiconductor manufacturer TSMC. For Taiwanese companies, the new rules will make it easier to forge strategic alliances with their customers or suppliers in China, which is already by far Taiwan’s biggest export market. The move is also a sign of greater comfort in Taiwan with establishing closer economic ties with China.

Another recent positive development was the Beijing government’s announcement in February 2011, as part of its 12th five-year plan, setting out six measures to stimulate the development of China’s software and semiconductor industries. In essence, the new policy will shift the emphasis for development away from pursuing capacity and output growth and towards improving R&D capabilities. Semiconductor firms meeting certain conditions will be eligible to receive state funding support, and the government will also introduce new tax breaks and incentives to encourage independent innovation. Taiwan’s semiconductor companies welcome the new policy and may decide to expand their investments in China to take advantage of the tax breaks on offer.