Electronics Production | December 12, 2007
Consumer electronics key to stable semiconductor outlook
Fitch's 2008 Rating Outlook for the semiconductor industry is stable, mostly driven by the expectation of solid unit growth for PCs and mobile handsets.
As the semiconductor industry continues to expand its total available market while pursuing a lower-capital intensive profile, Fitch believes the industry will experience less volatility and relatively more predictable free cash flow. Consistent with the broader technology industry, Fitch expects several semiconductor companies will continue to evaluate potential opportunities to alter their mostly equity-dominated capital structures via acquisition activity and/or potential debt-financed stock buyback actions, resulting in additional technology debt issuance. From a business and operating profile standpoint, as well as within the context of Fitch's credit considerations, semiconductor companies continue to be subject to the highest technology risk within the technology industry. Fitch believes the global semiconductor industry will grow in the low single-digit range in 2008, following modest revenue growth for 2007. Embedded into Fitch's expectations are that unit demand - particularly for consumer electronics - will remain solid, semiconductor content within an ever widening range of applications will expand further, and increasing consumer spending in developing economies will partially offset slower spending anticipated in the U.S. and Western Europe. However, Fitch's expectations for significant pricing pressures, excess manufacturing capacity for the memory segments (DRAM and flash memory), which aggressively added capacity in 2007 to meet strong NAND demand, and slightly elevated inventory levels (albeit still within manageable ranges) will weigh on otherwise solid growth drivers. Book-to-bill and inventory metrics remain within rationale ranges by historic standards, and Fitch believes any potential correction is likely to be significantly less severe than the more than 30% decline experienced in 2001. Several key trends impact Fitch's outlook for the semiconductor industry in 2008: Consumer Electronics: Fitch believes that consumer electronics will continue to be responsible for the majority of semiconductor unit growth in 2008. Fitch also believes consumer electronics devices will be sold increasingly into developing economies and, therefore, at lower average selling price (ASP). As a result, efficiently bringing new products to market is increasingly becoming the competitive differentiator for original equipment manufacturers (OEM) and prompting semiconductor makers to use foundries for process development and manufacturing, outsource back-end packaging and test, and form research and development partnerships. Ultimately, Fitch expects continued pressures on returns on investments will prompt long-awaited consolidation in certain segments. Increased use of foundries: Fitch believes foundries will expand their share of global integrated circuit (IC) production in 2008, due to the continued increase in use of foundries by integrated device manufacturers (IDMs) - albeit to varying degrees - and the rise of 'fables' semiconductor suppliers. At the same time, Fitch expects foundries to gain a more vital role in the semiconductor industry through the development of next generation process technology, in addition to accelerating the ramp of leading-edge wafer fabrication services (such as 65nm) by converting more orders from older process generations to advanced technologies. The increased use of foundries by IDMs reduces ever more costly investments in manufacturing capacity, particularly at the leading edge, and over the longer-term should result in more stable and consistent free cash flow available for alternative uses, including share repurchases and acquisitions. Importantly, Fitch believes a greater use of foundries will result in the maintenance of a healthier supply and demand balance for the broader semiconductor industry, as foundries consolidate a significant amount of capital spending on leading-edge technology (required for cost effectively manufacturing volume, highly standardized products), despite the anticipation for a second consecutive year of reduction in foundry capital spending in 2008. Memory makers volatility: Fitch believes memory makers, mainly large integrated electronics companies who toggle between DRAM and NAND flash memory production based upon relatively dynamic demand prospects, aggressively added capacity in 2007 to meet strong demand for NAND in an increasing number of applications (driven by increasing storage capacity). Despite robust anticipated unit demand, Fitch believes memory makers will be negatively impacted by excess supply in 2008. Furthermore, because of significant competition in this highly commoditized market and that the vast majority of production is manufactured for use in consumer electronics devices, gross margins will remain extremely thin, prompting ongoing significant investments in leading-edge manufacturing capacity and ASP reductions for consumer electronics. Better inventory management: Fitch believes the electronics supply chain will continue to be disciplined in 2008, supporting continued stability within the semiconductor market. Due to investments into more advanced information systems, greater use of foundries and, as a result, less uneven in-house utilization rates, and increased inventory discipline by components distributors, the supply chain has become more efficient in correcting pockets of excess inventory. While inventory levels remain at the high end of acceptable ranges, recent inventory corrections have been brought back into equilibrium in one-to-two quarters, approximately half the time that such corrections took historically. U.S. Advanced Micro Devices Inc. (AMD): The Rating Outlook for AMD is Negative due to Fitch's expectations for further erosion in the company's competitive position and worsening financial flexibility in 2008. Financial and operating performance for the fourth calendar quarter of 2007 is a significant factor in determining the long-term outlook for AMD. Fitch believes AMD's profitability is likely to decline following ongoing delays in ramping next-generation products across platforms and Intel's extension of an already significant manufacturing advantage. While microprocessor unit demand is expected to grow in excess of 10% in both 2007 and 2008 due to a strong PC unit demand environment, Fitch believes AMD will be challenged to keep pace with Intel's product roadmap over the near-term, likely resulting in AMD's profitability deteriorating further in 2008 from already pressured levels. Fitch anticipates AMD's operating EBITDA for 2007 will decline 75% from 2006 levels. At the same time, Fitch expects Intel to use its manufacturing process technology lead (believed to be one full process generation) to maintain meaningful pricing pressures on AMD. Positively, profitability for AMD should benefit from the company's headcount reductions during 2007. As a result of competitive pressures and the resultant impact on profitability, Fitch expects AMD's financial flexibility will erode in 2008. Despite recently having received $608 million in net proceeds via an equity investment from the government of Abu Dhabi, Fitch expects AMD will likely need additional funding to support ongoing annual capital spending, which Fitch anticipates will remain in excess of $1 billion in 2008. Although AMD has continually lowered expectations for capital expenditures in 2007, Fitch believes the company will be challenged to meaningfully further reduce ongoing capital spending for 2008 and beyond without potentially jeopardizing supplier relationships with certain original equipment manufacturers (OEMs). In the near-term, the company's capital spending reductions will aid short-term liquidity. However, consistent with AMD announcing its intentions to pursue an 'asset light' strategy, Fitch believes AMD will need to expand outsourcing relationships in order to keep pace with Intel's capabilities over the longer-term. Freescale Semiconductor Inc. (Freescale): Fitch's Stable Rating Outlook on Freescale in 2008 is supported by the company's diversified end market, customer, and product portfolios, proven manufacturing outsourcing strategy, and leading market positions. While Freescale's financial flexibility remains modest, the company's free cash flow has exceeded Fitch's original post-LBO expectations, due primarily to aggressive cost cutting. For 2008 Fitch expects Freescale's revenue growth will be essentially flat and Motorola's (its largest customer representing approximately 25% of total sales) operating performance to only modestly and gradually improve throughout the year. Fitch believes negative rating actions could occur in 2008 if Freescale's profitability meaningfully erodes, which is likely in the absence of ongoing cost reductions (potential for research and development sharing and consolidating manufacturing facilities) or an improving mix, primarily higher margin analog and sensors business. Fitch believes Freescale's greatest opportunity to bolster free cash flow in 2008 will be to reduce its cash conversion cycle, which increased 10 days to a Fitch-estimated 71 days for the latest 12 months (LTM) ended Sept. 28, 2007 from the prior year period. Fitch believes the erosion in Freescale's working capital efficiency was primarily due to excess Motorola inventory, which should be reduced over the next couple of quarters. Spansion Inc. (Spansion): The Rating Outlook on Spansion remains Negative and is driven by Fitch's expectations for continued pressure on the company's financial flexibility. Financial and operating performance for the fourth calendar quarter of 2007 is a significant factor in determining the long-term outlook for Spansion. Fitch believes Spansion could achieve break even operating profitability in 2008 but will nonetheless continue to burn cash, albeit at a modestly lower rate than the more than $1 billion of negative free cash flow for the latest 12 months (LTM) ended Sept. 30, 2007. Unit growth prospects remain solid for Spansion, highlighted by a 1.3 times (x) book-to-bill ratio exiting the third calendar quarter of 2007 and share gains within the NOR flash memory market due to leadership related to MirrorBit technology platform. However, NAND memory's rapidly increasing storage capacity continues to curtail revenue growth opportunities for NOR (Spansion's primary market) in rapidly growing markets addressable by both NAND and NOR solutions. Despite Spansion's leading technology, Fitch remains concerned with the company's inability to command premium pricing, although price per bit trends turned positive in third quarter-2007 after declining meaningfully throughout the preceding year. However, Fitch anticipates Spansion's ramp of MirrorBit ORNAND products on 65nm from its recently opened 300mm manufacturing facility (Spansion 1) will reduce its cost structure, providing a boost to the company's profitability in 2008. Nonetheless, Fitch anticipates Spansion will pursue additional financing in 2008, given that liquidity is likely to be stressed given the company's cash burn rate. Texas Instruments Incorporated (TI): Fitch's Rating Outlook on TI is Stable and is also driven by the company's diversified end market, customer, and product portfolios, proven manufacturing outsourcing strategy, and leading market positions. TI's strong annual free cash flow, expected to approximate $2 billion, and financial flexibility also support the rating and stable outlook. Fitch believes TI is an example of a company in the technology industry that could issue debt to adjust its 100% equity-based capital structure, given expectations for a less capital-intensive operating model and, therefore, more consistent annual free cash flow going forward. Fitch believes the negative effect of continued ASP pressures related to a lower mix of handset sales (related to faster growing ultra low-cost phones) in 2008 will be mitigated by solid growth rates of TI's highly profitable analog and mixed-signal business, which represents approximately 40% of the company's semiconductor sales and serves thousands of small customers. Fitch believes TI's agreement to outsource the development of next-generation process technology to long-term foundry partner, TSMC, represents a next step in the evolution of its hybrid manufacturing strategy and, if successful, will lower capital spending requirements further. And while TI is anticipated to lose some share at Nokia, as global handset makers diversify their semiconductor suppliers, Fitch anticipates potential share losses will not be significant, particularly given expectations that Nokia will at least maintain its current share of a growing global handset market, and be partially offset by longer-term share gains at Motorola. Fitch's stable outlook for TI in 2008 incorporates that TI will continue to aggressively repurchase shares approximating annual free cash flow. Europe: STMicroelectronics NV (STM): The Stable Outlook for STM remains solid given the company's strong market positions in a number of segments with relatively good demand fundamentals. STM is number three worldwide in automotive ICs - which are forecast to enjoy above average growth over the next three-to-four years. A number three position in wireless communications has been strengthened in 2007 with a number of key partnership arrangements with Nokia. STM continues to focus on restructuring its business portfolio, via the announced flash memory joint venture with Intel, a key step in improving available opportunities for this business and reducing the stand alone risk from what is a quite challenging and capital intensive segment. Fitch expects consolidated earnings and cash flow will both benefit from the transfer of this business to the joint venture in 2008. Despite challenging operating conditions (particularly in first half-2007) STM has performed well in 2007, and is on plan to meet fiscal year targets. Cash flow performance has been solid, as the company generated EUR270 million of free cash flow in the first nine months of 2007 despite a significant increase in the 2007 dividend payment. Free cash flow largely accounts for an increase in cash and marketable securities to EUR3 billion at the end of the third quarter of 2007 and net cash to approximately EUR870 million. The rating is however unlikely to improve in the near-term given relatively low operating margins compared with international peers and the potential for increased acquisition activity in 2008. ASML Holdings NV (ASML): The Rating Outlook for ASML, the world's leading manufacturer of lithography equipment, is Stable. ASML has built a 65% market share in an industry in which it has only two competitors, Canon and Nikon, and believes that 70% market share is within reach. With its equipment installed at around 90% of fabrication plants worldwide it commands a significant pricing premium to its competitors and is consistently the first to market with next generation tools. With lithography representing an increasing share of equipment investment, and a high degree of flexibility in its cost structure, Fitch believes ASML is well-placed to post solid earnings and cash flow through the cycle. Despite the weak operating environment for many of its customers in 2007 the company posted strong sales for the first nine months of 2007, up 12% from the comparable year ago period, and with fiscal year 2007 likely to be another record year. Demand from the memory segment has been strong, despite the difficult conditions in these markets, reflecting the fact that ASML sales are driven by bit rather than end market growth. Fitch could foresee upward pressure on the rating in the event of a robust set of full fiscal year numbers, subject to any change in ASML's financial policies. Asia: Taiwan Semiconductor Manufacturing Company Limited (TSMC): Fitch's Rating Outlook on TSMC in 2008 is Stable and is driven by the company's broad product range, state-of-the-art technology, large production capacity as well as integrated service for IC design and manufacture that lead to its dominant market position and strengthening customer relationships. The long-term growth prospects of foundries, TSMC's ample financial flexibility and consistent free cash flow mitigates Fitch's concern on its reliance on outsourcing orders, continuous capital spending needs, and operating volatility due to the industry's cyclical nature. Fitch believes the negative effect of continued pricing pressures related to industry competition and slow technology migration by customers will be mitigated by continued growth for the overall semiconductor market in 2008, more outsourcing orders from integrated device manufacturers (IDM) and its acquisition of eight-inch facilities from Atmel Corporation to capture increasing opportunities in consumer electronics application (such as liquid crystal display (LCD) driver IC and power management IC). More conservative capital spending in 2008 is also likely to support TSMC's capacity utilization and hence its profitability. Fitch anticipates additional share repurchases by TSMC pursuant to an agreed upon orderly reduction in Koninklijke Philips Electronics N.V.'s (Philips) equity interest in TSMC. Nevertheless, Fitch believes TSMC's share buyback plans will have negligible negative implications on TSMC's credit metrics due to expectations for positive free cash flow and the maintenance of a net cash position in 2008. United Microelectronics Corporation (UMC): Fitch's Stable Rating Outlook on UMC in 2008 is supported by the company's full range of production capabilities, solid relationships with a diversified and growing client base, and strong market position as the second-largest dedicated foundry in the world. The increasing outsourcing of wafer fabrication by semiconductor suppliers and UMC's sound financial profile characterized by its strong cash flow from operation and conservative capital structure mitigates Fitch's concern on its reliance on outsourcing orders, capital intensity resulting from significant requirement in capital spending and R&D, and operating volatility related to the cyclical nature of the semiconductor industry. Fitch believes the negative impact of continued pressures on ASP related to slow technology migration by customers and its narrowed technology edge against competitors will be mitigated by strong unit growth of the overall semiconductor market in 2008 than 2007, more outsourcing orders from IDMs and its cooperation with Elpida Memory, Inc. in developing next generation memory technology to bring to market more advanced embedded memory system-on-chip (SoC) solutions. Fitch expects UMC to focus its operation on capacity utilization, profitability and cash flow with significantly reduced capital spending in 2008. Fitch does not expect UMC to conduct similar shareholder friendly action in 2008 in addition to annual dividends linked to regular earning, in view of its research and development of advanced process technologies and continued expansion of manufacturing capacity, including its second 300mm wafer fabrication plant. Hynix Semiconductor Inc. (Hynix): Fitch's Rating Outlook for Hynix is Stable, reflecting the company's strong position in the semiconductor memory market, proven technology, efficient production, and improved financial status. Hynix is the world's second-largest DRAM maker and third-largest NAND flash memory producer. Hynix has improved its cost-reduction capability and maintained pace with the global memory chip technology migration while maintaining a stable yield. Compared with competitors, Hynix currently has a lower production cost and a leading edge technology despite a lower installation ratio of 12-inch fabrication facilities, which is assumed to be more than two times more productive than eight-inch fabs. Nevertheless, Hynix is facing tough challenges. The volatile DRAM and NAND flash memory prices and large capital spending requirements for technological migration are major business risks for Hynix. In addition, the difficult pricing environment for NAND flash memory could result in further margin compression.
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