Semiconductors – More cash please!

Geopolitics and subsidies in the driving seat.

• Intel is asking Germany to increase the level of subsidy that it is providing to incentivize leading-edge manufacturing in Germany which indicates both how the current subsidies are not enough and also what dire straits Intel currently is in.
• Intel is looking for a further €4bn-€5bn in subsidies from the German government in order to restart its development of a leading-edge manufacturing facility in Magdeburg.
• A leading-edge Fab costs around $25bn to build and when one adds up Intel’s plans in Arizona, Ohio and Germany a pretty massive capital expenditure budget results.
• Unfortunately, this capital requirement comes just at the time when everything seems to be going wrong for Intel which has led to falling sales, margins and profits.
• This raises the very valid question as to whether Intel can afford this ambitious plan, and some have even voiced the once unthinkable thought that Intel could even go bankrupt.
• Intel has a point in asking for more subsidies as semiconductor manufacturing is all about the total cost of ownership and currently, manufacturing in Europe and North America is pretty uncompetitive.
• An excellent study by BCG in September of 2020 pointed out just how big the differences are and how much of the difference is due to state subsidisation.
• It also demonstrates in my mind that geopolitics is clearly in the driving seat of the semiconductor industry which could lead to an unusually large downturn for the industry overall.
• BCG indexes the total cost of ownership in the USA at 100 and estimates that for advanced logic TCO in South Korea and Taiwan is 20% cheaper while China is 28% to 37% cheaper depending on the willingness to transfer technology.
• Germany for advanced analogue is 1% more expensive than the USA.
• It also estimates that subsidies are responsible for 50% to 70% of the advantage in China while South Korea and Taiwan are in the same range but a little bit lower.
• It is important to note that this does not include the EU’s program of €43bn of subsidies (1.9 leading edge fabs) and the CHIPS act which offers $50bn of subsidies (2.0 leading edge fabs).
• The data clearly indicates that anyone wanting to build a leading-edge fab from a purely economic perspective would immediately select China but for years now, there have been no takers.
• This is due to the long-held concern about technology transfer and IP protection but more recently this has been greatly exacerbated by the ideological and technological rivalry between the USA and China.
• It also indicates that the CHIPS Act and the EU have not gone far enough to level the playing field in terms of TCO partly explaining why Intel is out asking for more subsidy to move forward with its German fab.
• Hence, I suspect the geopolitically driven agenda to diversify leading-edge semiconductor manufacturing from Asia is going to become more expensive as all semiconductor companies I know are always keen to receive more subsidies.
• The net result is that capex is currently being driven by geopolitics rather than economics raising the question of whether these new fabs are actually needed within the time frame within which they are being built.
• The semiconductor sector is notoriously lumpy and if a large amount of geopolitically-driven supply comes onstream before the market is ready to absorb it, then a large downturn will result.
• This means that delays to these new fabs coming onstream are probably good for the sector overall as the economy will have more time to get back on track after paying for the pandemic through the current, persistently high inflation.
• This theme leads straight to GlobalFoundries which although it does not have leading-edge, already has highly depreciated and hence, competitive fabs in locations that the geopolitical mood prefers.
• The stock is not cheap, but it is a no-brainer when compared to Intel at the moment.
• The same cannot be said for TSMC, MediaTek and Qualcomm who trade at lower multiples but are not nearly as well positioned when it comes to the geopolitical climate.
• I don’t see this situation changing much for as long as geopolitics continues to trump economic rationale.