Acuity Insight: The Digital World is Breaking the Semiconductor Demand Wave

“This time it’s different” – these are some of the most dangerous words in business, because it is hardly ever true. But sometimes things genuinely change, and those who can predict change often stand to be the leaders of the new normal.

We’re ready to predict that the cyclical semiconductor wave is breaking – changing from a notoriously boom-and-bust industry to a more predictably steady rise. The change has been brewing for eight years, and this is thanks to the fact that the world is becoming increasingly digital. Chip volumes are no longer dependent upon single product trends like mobile phones, but are spread across a broader section of modern life.

Credit: ExtremeTech

“The semiconductor market was once small and polarised, driven by a number of technology innovations such as the mobile phone, the PC and the laptop,” says Matthew Byatt, Partner at Acuity Advisors. Average semiconductor revenue CAGR is forecasted at 6% from 2016 to 2021, according to data from SEMI, compared to a CAGR of 2.3% in the 2011-2016 period. “What we’re seeing today is a proliferation of semiconductors. They are used in every aspect of our lives.”

“The number of semiconductor chips in cars has exploded”, adds Byatt, “they’re also all over our homes and cars – in smart fridges, dishwashers, in digital assistants like the Alexa – and in the data centres that power the Cloud”.

The demand for semiconductor chips has historically followed a traditional stage cycle that lasts four years: Introduction – Growth – Maturity – Decline. The introduction stage would see a new technology emerge – like the PC or the laptop – before the growth stage comes when the industry scrambles to service this new need. Maturity is reached when supply outstrips demand, ahead of inevitable decline before the next new cycle begins.

The semiconductor industry has repeatedly suffered through this process due to its inherent inertia. It takes a long time to design a chip, and to build a new fab to make it in. Then it takes time to manufacture the chip and integrate into a product. The total timescale needed amounts to several years, making for a lengthy cycle for a product whose success is often unpredictable. “Combine that with massive capex – building a fab is a huge commitment – and you get overcapacity to supply the chips for a particular wave,” says Byatt, who compares chip supply to a nuclear power station: “once it’s up and running you can’t just turn it off and back on again whenever you need it.”

How has Semiconductor Demand Changed?

As the chart illustrates, the consequences of this digitalisation of life is that the revenue and growth waves of the semiconductor industry are softening. “The semiconductor industry is no longer so beholden to just one new technology – it has diversified. As one tech declines, another appears. This way the waves counteract each other and the previous shock effect is dampened by a broader base,” says Byatt. Major chip manufacturers including Intel, Micron, Toshiba and Samsung all increased fab investments for 2017 and 2018. SEMI predicts fab equipment spending will reach a $63 billion in the coming year, creating two consecutive years of record investments.

This new wave pattern is only going to become more pronounced, as Big Data and artificial intelligence requires more processing power within end user equipment. “The number of semiconductor chips within everyday objects is going to keep increasing and the market will grow further. There will always be some cylicality, but the dips will continue to soften,” says Byatt.

What does this Mean for M&A?

The semiconductor industry has seen a significant amount of consolidation of late, in part thanks to this new stability. For fabless semiconductor companies that don’t make their own chips, there’s a lot to look forward to in terms of M&A. Early figures from this year suggest things have slowed down slightly due to the lack of megadeals, (2015 and 2016 saw deal values representing about eight times the average over the previous five years) but deal volume has remained at a similar level.

Next year is predicted to be no less exciting. As we wrote in a recent Insight Bite, Broadcom had already agreed to acquire NXP Semiconductors before it launched a $130 billion takeover offensive for Qualcomm, potentially creating the undisputed industry leader. The prospective Broadcom-Qualcomm deal has intensified speculation that the market for megadeals has peaked, but there’s still plenty of deal room left in the market as a whole.

“That boom-to-bust pattern looks like it’s coming to an end in terms of M&A, as it has become more stabilised,” says Byatt. “Thanks to product diversity, there will continue to be lots of great startups and small businesses being acquired by larger businesses, working across all sorts of products.”

This stabilisation does face a potential hiccup, especially for semiconductor companies that make their own chips. The Chinese semiconductor market is aggressively ramping up to bring on new capacity: Chinese-owned companies are expected to invest $6.6 billion in the coming year, having for the first time reached parity with non-Chinese investment in 2017. This could potentially cause overcapacity, or at least pricing pressure, but this will only encourage the key players to look towards consolidation.

Samsung, which earlier this year leapfrogged Intel to become the world’s greatest manufacturer of semiconductor chips, has already stated a desire to buy businesses to expand its product lines. Fortune reported that the company has an interest in buying smaller companies within healthcare, and business verticals such as industrial internet, automation, networking, data transmission and security.

Byatt believes we’re only at the beginning of a new surge in semiconductor M&A activity: “Because the industry has diversified across a broad product base, there are plenty of new applications that utilise semiconductors that need continued innovation. That’s going to attract some great engineering talent, and will lead to the formation of some innovative businesses which will attract the attention of the industry giants.”

In conclusion, we think it’s different this time because the world has changed. We have mobile apps, artificial intelligence, virtual and augmented reality, the Internet of Things, advancements in robotics, automotive, industrial, as well as 5G networking. Semiconductors lie at the heart of all of this, ensuring an exciting time ahead for the industry. Each of these advancements would be significant on its own, but together they make a sea change.

About Acuity Advisors

We know technology – that’s why we’re the industry’s trusted M&A advisor. Our partners are senior players in tech and M&A: skilled at getting to the heart of a technology business, understanding what will attract buyers, and building long-lasting relationships. We have an unrivalled understanding of the industry’s complexities and personalities – our track record and client feedback are compelling evidence of that. We’re an international firm – most of our deals are cross-border, from offices in London, Munich, Shanghai and Silicon Valley – but we’re grounded in our approach. We move quickly when it’s needed, and we’re around for the long haul when patience is a virtue. We’ve maintained a very high success rate across hundreds of deals while keeping our focus on doing what’s right for our clients. From first meeting to successful exit, we earn the trust that clients and investors put in us. Learn more here.

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