The semiconductor industry falls from record earnings into a recession

It’s a bizarre situation: while some chips are still expensive, demand for others is plummeting. Inflation and war unsettle buyers.

There has probably never been such a sharp swing from scarcity to oversupply in the semiconductor industry. It has been known for decades that supply and demand for many chips fluctuate rhythmically, i.e. follow the so-called pig cycle. Periods of high turnover are always followed by severe contraction. But what the industry has been experiencing since the beginning of 2020 is extreme:

At that time, the corona pandemic suddenly increased demand, which led to a continuing shortage of many components and in some segments (notebooks, office computers, printers, servers, webcams) to extraordinarily high sales growth. The sales figures, which fell as the pandemic subsided in 2022, spoiled the quarterly results of many IT companies: Compared to 2020 and 2021, things went down significantly.

Then Russia’s war of aggression against Ukraine plunged Europe into an energy crisis and inflation soared. Many customers are now keeping their money together and are making sacrifices. This in turn clouds the outlook and is poison for share prices, which are known to be fueled above all by good forecasts.

As in earlier downturn phases, the manufacturers of memory chips felt the decline particularly early, i.e. producers of DRAM for the main memory of PCs and smartphones as well as NAND flash for SSDs, USB sticks, and memory cards. Demand is falling rapidly, as is price.

When presenting the results for the third quarter of 2022, SK Hynix, the second largest memory chip manufacturer after Samsung, spoke of a “never experienced downturn”. Micron and Kioxia are drastically reducing their investments in new production facilities, Micron by 50 percent. Intel had to report losses for two quarters in a row and is planning “adjustments”, i.e. probably layoffs. The hard drive manufacturer Seagate – which has only two competitors with Western Digital and Toshiba – wants to lay off around 3,000 people, around 8 percent of all employees.

In Ireland’s Fab 34, Intel employees install machines for additional manufacturing capacity. Currently, however, the demand for Intel chips is clearly going downhill. (Image: Intel)

Success-drenched Nvidia was already feeling the effects of the downturn, and AMD missed revenue guidance by $1.1 billion (almost 17 percent) in the third quarter after proudly reporting record results in the first half of the year.

The large contract manufacturers – above all the Taiwanese company TSMC – did very good business in the third quarter of 2022, but they make the most money with the most modern chips. But many devices have older chips, some of which are still in short supply. For some programmable logic chips (FPGAs) and microcontrollers, distributors are not naming delivery dates until mid-2023 and they are also charging several times the prices that were usual until 2020.

The Raspberry Pi should not be available again until 2023, because certain components will not be available in sufficient quantities until then. Because relatively simple chips come from older production plants whose capacity is exhausted: On the one hand, high investments are not profitable for them, on the other hand, production machines are hardly available because the few special manufacturers build more lucrative machines for modern chips.

It takes three to six months for a silicon wafer to be processed into fully packaged and tested chips. The construction of a new chip factory (fab) even takes several years. Therefore, the construction of new chip fabs cannot solve acute bottlenecks. Apart from that, the production capacities for many pre-products of chip production are also limited, for example for wafers.

The current picture is particularly contradictory. The USA and the EU are funding the construction of new chip fabs with sums in the billions, the approval of which couldn’t have happened quickly enough when there was a shortage of chips. Intel alone is planning investments of more than 80 billion euros in the USA, the EU, and Israel over the next eight to ten years. Among others, the chip manufacturers TSMC, Micron, Samsung, Texas Instruments, Globalfoundries, Bosch, Infineon, STMicroelectronics, and Vishay are currently building new fabs or expanding existing ones. It is roughly estimated that more than half a trillion euros will flow into new fabs in the next few years.

Fueled by subsidies, several chip makers are building large “fabs” in the US and EU. Texas Instruments wants to invest up to 30 billion US dollars in Sherman/Texas. (Image: Texas Instruments)

Until recently, this seemed to be absolutely justified, because all forecasts predict a sharp increase in demand for semiconductor components in the medium and long term. Growth drivers are computationally intensive AI algorithms that are required to automate cars, industrial production, and services. In addition, there is ongoing digitization, especially in authorities and education. Data centers and (5G) data networks will also need a large number of chips.

However, the sales of many semiconductor companies are currently collapsing and the short-term forecasts are rather gloomy: there is no end in sight to the war between Russia and Ukraine. The restructuring of the energy supply will take years and inflation is unlikely to subside anytime soon. On the one hand, energy prices will remain very high for the time being, and on the other hand, many goods will become more expensive if they are produced again in western industrialized countries in order to reduce dependence on China.

US President Joe Biden emphasizes the strengthening of the domestic chip industry. However, China is not only important for the industry as a supplier country, but also as a growth market for electronic devices. (Image: Intel)

This is on the agenda of many manufacturers and governments because the political and economic relationship between the People’s Republic of China and “the West” is a huge factor of uncertainty. A few weeks ago, the USA issued new and stricter sanctions against Chinese chip companies. These should primarily hinder the development and production of modern semiconductor components for supercomputers, weapons, and AI systems. But they are likely to affect Chinese chip companies in general.

Although they have so far only been of minor importance on the world market, China could counter the US sanctions with its own sanctions against Western companies. China would cut itself in the foot with this but could accept it in order to damage its existing trading partners in the USA, the EU, Japan, and Korea even more. To give an example: German automobile companies sell more than every third vehicle in China. The growth of many chip manufacturers and their suppliers also depends crucially on Chinese customers.

In other words, a trade war between China and the US, and the EU could destroy what has been a rosy medium-term outlook for chips. It is true that the demand for chips will also increase significantly within the western industrialized nations in the coming years. But if the Chinese sales market, which accounts for around 18 percent of the world’s population, weakens or, in extreme cases, even collapses, it will be difficult for many companies.

However, it is currently considered unlikely that China will be largely sealed off from the western market. Because China also has a lot to lose: the economy is no longer growing as fast as it used to, partly because of the tough lockdowns. In this situation, additional loads are more difficult to cope with. However, China does not want to be interfered with in its own politics. On the contrary, Xi Jinping has continued to consolidate his power. However, the USA and the EU criticize many aspects of Chinese politics: the threat to Taiwan, the disregard for human rights, the oppression of minorities such as the Uyghurs, the purchase of Russian raw materials, the strategic acquisition of companies in industrialized countries and major projects such as the new Silk Road.

There is therefore considerable potential for conflict between the closely intertwined trading partners and long-held assessments have changed. The war against Ukraine has discredited the concept of “change through trade” for many. US President Joe Biden shows a clear edge against China and US companies dominate the chip industry. In view of the many other imponderables – energy prices, security of supply, supply chains, inflation, and pandemic – semiconductor companies can plan poorly. However, the high investments in new chip fabs can also be stretched out over longer periods of time if demand increases more slowly than previously planned.

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