Second-Half Chip Forecast: Hang On To Your Hat

Semiconductor roller coaster

This is the time of the year when chip industry watchers agree to disagree.

Some forecasters have recently raised their chip predictions for 2006, while others have lowered their numbers amid lackluster growth in the PC and consumer sectors. "There are also inventory concerns in the market," warned Mark Bachman, an analyst with Pacific Crest Securities Inc. (Portland, Ore.).

Current IC growth forecasts among analysts range from 6-11 percent for 2006 over 2005. Two mavericks— Future Horizons (Sevenoaks, England) and Semico Research Corp. (Phoenix)—remain at the high end of the scale with bullish predictions of around 20 percent and 17 percent growth, respectively.

As usual, there is plenty of uncertainty in the market. The problem is that the industry analysts rarely get their forecasts right and are always changing their predictions based on current market conditions.

One of the more sobering and realistic predictions, is from iSuppli Corp.. It has increased its IC forecast by a half-percentage point, going to 7.9 percent, up from 7.4 percent. Worldwide IC revenue is expected to rise to $255.7 billion in 2006, up from $237 billion in 2005, according to iSuppli (El Segundo, Calif.).

Despite decent demand for equipment, the semiconductor market outlook isn't all rosy, iSuppli warned. The higher-than-expected growth seen in the first quarter will be followed by some sluggishness in the second half. Second-half growth of 5 percent is less than the normal seasonal expectations for the industry. Orders appear to be weakening as inventories rise, it warned.

Another concern is reported delays with Apple's next-generation iPod products—a key driver for NAND flash, MP3 processors and other devices.

But even before the reported iPod delays, analysts were already jumping on the bear bandwagon following at least one red flag in the market: sluggish chip sales in April.

April's dismal numbers prompted Wedbush Morgan Securities Inc. (Los Angeles) to lower its 2006 semiconductor growth forecast one point to 10 percent. For 2007, Wedbush projects the IC market will slow, growing by only 6 percent over 2006.

In a new report, Handelsbanken Capital Markets projects that the semiconductor market will now grow 5 percent in 2006 over 2005, down from 6 percent in its previous forecast. The investment banker blamed the lowered forecast on the worldwide PC slowdown.

Handelsbanken also expects lackluster sales in May. The three-month average of May chip sales is projected to hit $19.37 billion, compared to $19.6 billion in April, according to the firm.

Not all are in the bear camp. Industry cheerleader, the Semiconductor Industry Association (SIA), recently boosted its projected worldwide chip sales forecast for 2006, and now projects growth of 9.8 percent to $249 billion, up from its previous estimate of 7.9 percent growth to $245 billion. SIA (San Jose, Calif.) said the correction is mainly due to better than anticipated demand for chips by the mobile phone sector.

The revised forecast also includes more optimistic projections for industry sales from 2006 through 2009. SIA said the industry will grow by 11 percent in 2007, 12 percent in 2008 and 4 percent in 2009.

The World Semiconductor Trade Statistics (WSTS) organization also raised its semiconductor forecast. The global IC market is expected to grow 10.1 percent on an annualized basis to $250 billion in 2006, according to WSTS's spring forecast. Projected growth worldwide will accelerate to 11 percent in 2007 and 12.8 percent in 2008, according to the organization.

EDA's surprising strength

EDA may be as healthy as its been in years heading into the second half of 2006. The industry returned to double-digit growth earlier this year and is now gearing up for its premier event, the Design Automation Conference in July.

Yield issues continue to pain chip makers, and there is a good deal of money at stake for vendors who can provide the oft-discussed but elusive design-for-manufacturing (DFM) solutions. The industry has recently witnessed a breakthrough in what had been considered one of the most pressing DFM logjams: silicon foundry giants Taiwan Semiconductor Manufacturing Co. Ltd. (TSMC) and United Microelectronics Corp. (UMC) offering fab data models designed to give fabless customers information about manufacturing processes. The move could level the playing field between fabless companies and IDMs on DFM issues.

Dennis Wassung, an analyst and vice president with Canaccord Adams, recently said the market for DFM tools is currently worth $350 million to $400 million annually, and is poised for substantial growth.

Precise definitions of the market for DFM tools differ, and executives like Aprio Technologies President and CEO Mike Gianfagna have noted that if EDA vendors can find a way to sell into chip makers' manufacturing budgets—which are significantly larger than design budgets—it could mean a windfall for the EDA industry, providing a much needed new source of revenue.

There are indications that DFM tools are starting to come into their own after years of development. DFM has been little more than a marketing push, but now at least some DFM tools have entered production. Deepchip.com moderator John Cooley recently published the results of a census that included, among many other things, what he believes to be the first published user review of a DFM tool—UMC's Chien Kuo Wang reviewing ClearShape Technology's InShape tool.

Elsewhere, electronic-system level (ESL) tools, supposedly EDA's other big technology driver, have yet to catch on, at least in the U.S., according to an analysis of available data. But ESL vendors and some observers, notably Gartner analyst Gary Smith, said the ESL tool flow is finally robust. Most observers agree that designers will move to ESL eventually. The question is when.

For now, evidence suggests that ESL use is still primarily concentrated in Japan and, to a lesser degree, in other markets outside the U.S.

So how will EDA fare in the second half of 2006? As Mentor Graphics Chairman and CEO Walden Rhines told EE Times this week, EDA could maintain a pace set with its 10 percent year-to-year growth in the first quarter. This depends on whether the IC market continues to expand. With most analyst predicting chip growth ranging from 6 to 20 percent. Hence, 2006 could be a strong year for EDA. Display volatility

The relentless expansion of manufacturing capacity appears to be catching up with the flat-panel display industry as it faces a volatile second half of 2006.

Although flat-panel display shipments remain strong, several suppliers in recent weeks have scaled back sales and earnings expectations due to slower-than-anticipated demand, growing inventory and falling prices. In addition, at least one major LCD panel supplier said it would scale back production.

Rapidly falling prices are compounding profitability concerns.

LCD TVs have experienced some of the sharpest drops, with some analysts noting that panel prices for 32-inch TVs fell 50 percent between the first quarter of 2004 and fourth quarter of 2005, from $1,200 to $600.

According to data compiled by another market researcher, DisplaySearch Inc. (Austin, Texas), prices for 32-inch WXGA LCD TV panels dropped from an average of $550 in January to $450 the second half of June. For 42-inch WXGA LCD TV panels, prices fell from an average of $1,050 to $815 over the same period.

Plasma display prices also continue falling in price. DisplaySearch reported 42-inch high-definition plasma TV screens fell from $759 in January to $682 in June.

"Each time the flat-panel market has undergone a reduction in pricing, revenue has dropped, profit margin has dipped and then players have dropped out of the market," Sweta Dash, director of LCD and projection research for iSuppli, said during a recent display industry conference.

So far, there's no indication that anyone is dropping out. But Dash said LCD suppliers will continue to be pressured to lower panel prices amidst intensifying competition in the TV market.

Some suppliers are taking precautions. LG.Philips LCD Co. Inc. downgraded its second-quarter forecast, adding it would scale back production to address inventory concerns. LCD glass supplier Corning Inc. also lowered its second-quarter forecast, though still expects to glass volume to grow 40 to 50 percent for the year.

But Samsung Electronics said its LCD business remains profitable, and would post single-digit profit margins in the second quarter.

If you believe the display industry will follow its historical pattern of alternating cycles of weak pricing/weak demand followed by stronger pricing/stronger demand, the second half should be better. Analysts believe attractive prices will stimulate demand for the holiday season, in turn depleting excess inventories and eventually slowing down the rate of price erosion.

Such a scenario held true last year, when some display companies reported lagging profits at the end of a less-than-stellar first half. But sales surged toward year's end as flat-panel TVs went mainstream. LCD suppliers continued to pour hundreds of millions of dollars on 7th and 8th generation fabs, and plasma display makers also opened new fabs.

Backdating blues

On top of rising interest rates that will increase the cost of capital, steadily rising energy prices and shortages of key materials like polysilicon, add to the second-half industry outlook the specter of a full-blown stock-option backdating scandal. This past week, the scandal reached as high as industry stalwart Apple Computer.. There is growing unease that the practice is widespread in an industry built on stock option incentives, attracting unwanted scrutiny from regulators..

Responding to pressure, the U.S. Securities and Exchange Commission is expected to hit the industry with new guidance on the backdating of stock options any day now. Either way, a lot of industry earnings reports will likely have to be restated.

Another financial issue is emerging that could affect the way capital flows within the global industry. An industry analyst is arguing that U.S. financial disclosure rules approved by Congress in the aftermath of the Enron debacle may sharply curtail U.S. high-technology IPOs. According to Charley Lax, managing general partner of GrandBanks Capital, provisions of the Sarbanes-Oxley Act may be forcing high-tech startups to list instead on the London exchange.

Energy costs continue to exact a price on company earnings, but have also prompted some suppliers to shift their focus to new markets beyond semiconductors and consumer electronics. Case in point: Germany's Wacker Chemie AG said this week it will expand polysilicon production to meet growing demand by the solar cell industry. The Munich-based manufacturer said it hopes to boost capacity to 14,500 metric tons by the end of 2009 to meet soaring demand from the energy sector as well as from traditional semiconductor customers.

The announcement could foreshadow a fundamental industry shift to new markets as semiconductors increasingly become commodity items.

—Contributors to this article are: Mark LaPedus in San Jose; Dylan McGrath in San Francisco; Spencer Chin in Manhasset, N.Y.; and George Leopold in Washington.