Semiconductors – Politics not economics.

Geopolitics is firmly in the driving seat.

• Samsung has announced its intentions to triple its foundry business from 2021 as well as migrate from 5nm to 1.4nm within a 5-year time horizon in another sign that the foundry opportunity and the build-out of leading-edge is being driven by geopolitics rather than economics.
• Samsung is holding its annual Foundry Forum in San Jose which kicks off a world tour ending in Korea on the 20^th of October where it outlines its plans and showcases its offering to customers and prospects.
• Currently, the most economic place to build a leading edge fab by far is in China as a result of the generous terms being offered by the Chinese government.
• In fact, a study by BCG group demonstrated that government subsidies are one of the largest factors in the total cost of ownership of a fab and that China and Taiwan are more cost-effective than anywhere else.
• Despite this, plans are afoot by Intel, Samsung and TSMC to build leading-edge fabs in the USA which even with the CHIPS Act is still likely to have a higher cost of ownership than China, Korea or Taiwan.
• The problem to date has been the combination of rising tensions between the USA and China and the location of current leading-edge manufacturing capacity.
• As things stand today 100% of all leading-edge capacity is in Taiwan and Korea both of which are within striking distance of China in geopolitical terms.
• As electronics have increasingly permeated through different industries, including the military, semiconductors have been increasingly viewed as a national security issue and concerns surrounding semiconductor security have become more prevalent.
• This is why there has been a push to ensure that leading-edge semiconductor manufacturing is diversified away from China’s backyard.
• This concern continues to rise despite the worsening demand picture that may very well tip the semiconductor industry into a downturn.
• Over the last 3 years, demand has been very strong for electronics which was further boosted by everyone being stuck at home for the best part of 18 months.
• However, the time has come to pay for the pandemic and the method of choice appears to be inflation which looks set to persist for another year or two.
• The net result of this is that the inflation tax will eat away at people’s disposable income and their savings meaning that demand for electronics is going to be soft for a while.
• There are signs of this everywhere and companies like Micron are already making cuts but those building leading-edge fabs are pressing on nonetheless.
• This is why I fear that we are entering a significant downturn for the semiconductor industry as a drop-off in demand and the continued capacity additions is moving the industry quickly into a position of oversupply.
• I have been expecting this to begin sometime between H2 2022 and the end of H1 2023, and at the moment this estimate looks to be about right.
• Hence, I am getting increasingly nervous about the outlook for the semiconductor sector and continue to prefer the defensive end of the semiconductor cycle.
• Here, I prefer Qualcomm, MediaTek and TSMC although TSMC is beginning to look riskier than the other two.
• This is because Qualcomm and MediaTek do not own any fabs making it much easier for them to adjust to a downturn in demand.
• These are the two that I would own if I had a position in semiconductors (which I don’t) but also Samsung is beginning to look interesting again especially if one is investing on a USD basis.