Semiconductor Industry

The metrics determining the 2009 outlook for the Semiconductor industry as a whole has been as volatile as ever. Pricing (ASP Erosion) and inventory buildup in the latter half of 2008 has plagued the industry and companies, particularly in the Specialized (SP) and Integrated Circuits (IC) areas, are still having a difficult time managing inventory to bring utilization rates to an optimal level for margin maintenance and growth.

The peak season for NAND flash in 2008 only lasted till the month of October, and prices for 16Gb and 32Gb chips fell again in November. Price adjustments during July and August of 2008 helped demand recover in October, but the poor showing of consumer electronics sales during the holiday season, aggravated by the global financial crisis, is expected to shrink demand for NAND flash again in 2009. Within the large-size shipments, IT applications dropped 7% sequentially in Q4:08 to 19.2 million units due to inventory adjustment by makers.

It is widely expected that the true demand decline will bottom out at roughly negative 20% y/y (best-case scenario), as we expect semi ASPs to largely remain on a stable curve. Data flow will likely remain more negative than Street estimates. However, we think that semis are largely equal-to-under-weighted as a sector, with investors looking for a snap-back in the second half of 2009, driven by end market stabilization and moderated inventory coverage.

We believe pricing adjustments will be the key drivers for reviving 2009 consumer demand. In our opinion, these pricing adjustments are largely factored into 2009 revenue estimates. On the IC front, we are encouraged by companies with broader exposure and with product cycle trends towards digitization of consumer electronics and the growth of mobile Internet devices.

WEAKNESSES

End-market weakness is co-related to volatility in spaces such as PCs, handsets and consumer electronics, while areas like communications and industrials, although still weak, are relatively better. Nonetheless, in infrastructure we may continue to see push-outs of new product launches, driving higher legacy equipment sales which may turn out to be positive for vendors such as LSI Corp. (LSI - Analyst Report, Hold) and Vitesse Semiconductor.

Companies in the Semi space in general are controlling spending more carefully than any previous time in the technology's history. Projects that are in progress are being delayed and very few new projects are going through, except those that can impact the corporate bottom-line directly and quickly. Existing network infrastructures may continue to be used as-is while companies re-establish spending priorities.

If processors and disk drives and software sales are poor, there is little reason to think that there would be much need for expanding corporate networks. As companies cut jobs, there are fewer workers using network seats and accessing corporate data resources. A shrinking user base makes it much more difficult to justify new technology purchases.

Planned upgrades to higher speed technologies such as 10 Gigabit Ethernet or Data Center Ethernet are being re-evaluated and sometimes postponed indefinitely until companies feel comfortable spending money again. In general, technology sales cycles have slowed considerably, and technology leaders are being asked to leverage existing equipment as much as possible. The information industry has never seen the drive for technology fall to levels this low before.

OPPORTUNITIES

Historically speaking, the Semiconductor sector is able to manage and recover from periods of weak demand. Management teams, for the most part, know how to handle supply-chain and end-market changes with both temporary and permanent actions that will result in earnings power recovery.

On the product side, we expect mobile Internet devices to begin to show signs of being the next billion-unit electronics opportunity, with broad OEM rollouts and increasingly exciting form factors. We also expect to see smartphones continue to evolve through improving co-processors, such as NVIDIA (NVDA - Analyst Report), Broadcom (BRCM - Analyst Report, Hold) and Texas Instruments (TXN - Analyst Report); touch technologies, such as Atmel (ATML - Analyst Report, Hold), Cypress (CY - Analyst Report) and Broadcom; improving interfaces, embedded wireless (BRCM); and efficient power amplifiers, such as Skyworks (SWKS - Analyst Report, Buy), RF Micro Devices (RFMD - Snapshot Report), TriQuint (TQNT - Analyst Report, Hold) and Anadigics (ANAD - Analyst Report, Hold).

Additionally, with the increasing sophistication of home/automotive microcontrollers from companies such as Silicon Labs (SLAB - Analyst Report), Atmel, CY and TXN, we expect greater demand. Specifically, we expect greater progress in auto infotainment, increased use of near-field communications/home automation and more low-power battery powered microcontrollers. We also believe the fundamental demand trends for 2009 remain strong for telecom network buildouts and enterprise network/storage/server spending, despite near-term spending weakness.