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China set to flood the world with
chips
By Macabe Keliher
TAIPEI -
Last September Morris Chang alarmed the semiconductor
industry when he said there would be an industrywide
recession in 2005 and that the Chinese chip makers would
cause it. "I stand by that statement. China's capacity
in 2005 will have a big impact," the 
chairman of the
world's largest made-to-order integrated-circuit and
computer-chip manufacturer, Taiwan Semiconductor
Manufacturing Co (TSMC), has told Asia Times Online.
That's something of an understatement. In
pursuit of a policy that will make China nearly
self-reliant in semiconductor manufacturing, and enable
the country to source its own chips domestically for
everything from tape recorders to computers, Beijing is
funding and bankrolling what is being called reckless
expansion in semiconductor fabrication plants, or
"fabs". Through low-interest loans, tax exemptions and
even direct investment, the Beijing government has set
China on pace to provide the world with 20 percent or
more of its capacity next year in the made-to-order chip
industry, or foundry.
This volume is enough,
industrialists and analysts say, to cause a serious glut
that will drive down prices, slash profit margins and
suppress return on equity. From a robust 20-30 percent
growth this year to more than US$200 billion, the global
semiconductor industry will register only 10 percent or
less in 2005, according to Chang, and some analysts are
predicting negative growth. "Just as in any industry
governed by supply and demand, an increase in capacity
anywhere in the world will have effects," said Chang,
interviewed at a TSMC investors' conference here last
Thursday.
When Beijing designated the
semiconductor industry as one of China's pillars of
economic growth, the industry was sure to take off, and
what has occurred is unprecedented on any scale. From
virtually nothing a few years ago, Chinese fabs hold
about 9 percent of the foundry market's capacity today,
and they are expected to produce 15 percent of the
industry's chips by the end of the year, and well over
20 percent in 2005.
China is sitting on a
mountain of wafers
Take, for example,
Semiconductor Manufacturing International Corp, China's
largest manufacturer. It currently has three
eight-inch-wafer fabs in Shanghai that will increase
capacity by 70 percent this year. Add a recently
purchased Tianjin eight-inch fab, a 12-inch fab in
Beijing that is expected to go online in the fourth
quarter, and two more 12-inch fabs scheduled for 2005
and 2006, and China is sitting on a mountain of wafers
that the market is just not ready to absorb.
"The overcapacity will be massive. And taken
with a modest fall in global chip sales, there will be a
rough landing for the industry," said Rick Hsu,
semiconductor analyst at Nomura Securities.
As
part of the government's strategy, Chinese foundries aim
to supply the local market. Currently almost 80 percent
of China's chip demand, which totaled about $22 billion
last year, is being met by foreign makers. The Chinese
government hopes to raise the country's self-sufficiency
above 50 percent in the coming years, and has invested
heavily in a few of the companies. Advanced
Semiconductor Manufacturing Corp, for instance, is 62
percent government-owned, and Grace Semiconductor
Manufacturing Corp is partially held by the son of
former Chinese president Jiang Zemin.
In addition
to owning majority stakes in some of the semiconductor
companies, China offers tax incentives to semiconductor
investments. Chip makers pay no income tax in the first
five years of investment and then pay half of the
regular tax in the next five years. The standard
income-tax rate is 15 percent, well below that of many
developed countries, including Taiwan's 25 percent.
These tax incentives, along with lower land and labor
costs, give Chinese companies a cost advantage. They can
manufacture about 10 percent more cheaply than their
competitors elsewhere, according to Andrew Lu at
Citigroup Smith Barney.
With these political and
financial incentives, analysts estimate that Chinese
companies will increase their wafer-manufacturing
capacity by nearly 60 percent by the second half of this
year. Such a trend is only expected to intensify until
Chinese makers can fill more than 50 percent of the
domestic demand, possibly regardless of whether there is
new demand or not.
Analysts warn that the local
market is expected to grow less than 20 percent this
year and about 13 percent next year - a rate slower than
that of the manufacturing capacity. "There is a demand
shift, not the creation of demand," said Hsu, at Nomura.
"Foundries are unlikely to see a return to the days of
ROEs [returns on equity] in the 20 percent range."
China's mass chip production to hurt
others
Although Chang said Taiwan Semiconductor
Manufacturing's 2003 fourth-quarter return on equity was
19.9 percent, and that he expects more than 20 percent
by this June 30, all of those high numbers may drop when
Chinese companies begin mass production in their new
fabs, probably some time next year. Nomura estimates
that TSMC will recover to only 18 percent return on
equity in 2005, the year in which the chip cycle is
expected to peak. TSMC's ROE peak was in 1995, at 45
percent.
"The pricing power of Taiwan's
foundries in this sector should just about disappear,"
said Hsu. He estimates that China foundries sell at
about 20-30 percent lower than the industry as a whole,
and 40-50 percent lower than TSMC.
The industry
is in the midst of an upswing now, to be sure.
Arizona-based Semico Research Corp forecasts 26.8
percent revenue growth for the global semiconductor
industry this year, and 39.7 percent growth for the
foundries. And last week TSMC announced record revenues
for fourth-quarter sales in 2003, an increase of 5.3
percent over the third quarter, and Chang said he
expects single-digit growth in the first quarter of
2004, monumental in an industry that peaks in December.
Profits for TSMC in the fourth quarter rose sixfold over
2002.
The problem is, the industry overall is
expanding. TSMC is raising its capital expenditure by 60
percent this year to $2 billion, and United
Microelectronics Corp, the world's second-largest
foundry, is expected to increase its capital expenditure
fourfold, from $350 million to $1.5 billion. The Chinese
companies are planning initial public offerings, either
in Hong Kong or on the United States Nasdaq in the next
year or so. China's largest manufacturer, Semiconductor
Manufacturing International Corp, for instance, will
float a $1 billion initial public offering (IPO) in the
first half of this year. Grace is also scheduling a $3
billion IPO, probably next year.
"Enjoy it while
it's great," said Dan Hutcheson, president of US-based
VLSI Research Inc, "but expect a decline on the order of
30 percent to start in late 2005."
(Copyright
2004 Asia Times Online Co, Ltd. All rights reserved.
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