The Broad View
Some products travel well. Semiconductors, once shackled to desktop computers, now are never far from our side. They’re in our smartphones and our cars. At work, chips are the lifeblood of laptops, copiers and even some coffee machines. At home, they provide essential bridges in our personal lives, connecting us to retailers, to entertainment and, vitally, to each other.
Put another way, chips have become our constant companions, and society’s reliance on them is likely to keep expanding as the definition of what qualifies as technology continues to broaden. With processors growing in power and sophistication, they’re increasingly threaded into industries such as health care, manufacturing, robotic equipment and artificial intelligence.
To be sure, the industry faces hurdles in the near term, including its inherent cyclicality. Ravenous demand from tech giants such as Amazon and Google cooled last year, with the slowing global economy and maturing smartphone market triggering a bout of share-price volatility. After a strong rebound early this year, chip stocks were hit once again, this time by heightened trade friction between the U.S. and China.
Nevertheless, semiconductors lie at the heart of technological innovation and my long-term outlook remains highly optimistic. I expect moderate growth — somewhere in the mid-single digits — to resume in coming years. Beyond that, the prospects are especially promising for individual companies with clear technological expertise and differentiated products. Below are some of the reasons the semiconductor industry remains attractive.
Though demand from smartphone makers such as Apple and Samsung appears to be decelerating, other types of manufacturers continue to ramp up the technological prowess of their products. For instance, the average new car features more than 30 computer chips, while luxury vehicles often have more than 100. Among medical devices, adoption has been slowed by regulatory barriers, but the potential is substantial, particularly in robotic surgery.
Internet-connected consumer products are also becoming ubiquitous. Android and iPhone handsets can now control everything from home security systems to backyard sprinklers. Refrigerators can automatically order food via online delivery services. These products all require smaller and more specialized chips.
The move to 5G, or fifth generation, cellular connectivity is also underway. It may feel like an evolutionary shift at the moment but, in my view, it will lead to revolutionary advances. The limits of 4G will be largely eliminated, especially high latency due to lower speeds, and devices will be able to communicate with one another almost instantaneously.
Once 5G becomes widely available in the next few years, it will create new business models and boost the current tech giants as internet search, social media and e-commerce become more ingrained in daily life. Artificial intelligence applications and virtual reality devices, both of which require advanced chips, are likely to proliferate.
The semiconductor industry — which includes designers, chip manufacturers and equipment makers — is experiencing the same consolidation pressure as other sectors, and mergers are reshaping the landscape. In 2003, for example, there were 25 manufacturers of logic chips. Today, the business is dominated by three companies: Intel, Samsung and Taiwan Semiconductor. In specialized areas, there often is only one supplier, such as Dutch chip-equipment maker ASML, whose extreme ultraviolet lithography machines produce the most advanced chips in the world and cost upward of $100 million.
Consolidation is a sign that the business is maturing and that the days of supercharged growth are giving way to moderate and even slow growth. However, the industry’s financial impact continues to loom large. In 2018, chip companies generated record sales of $468.8 billion, up 13.7% from the previous year, according to the Semiconductor Industry Association.
There’s no doubt that trade wrangling between the U.S. and China is casting a shadow over chip companies. Deals have appeared within reach and then dissolved amid ramped-up U.S. tariffs and sharpened rhetoric. The fracas has created significant question marks — for example, what will become of Huawei, a massive Chinese cellphone and cellular communications manufacturer that has been effectively shut out of the U.S. market.
Still, it’s important to point out that last year’s record sales came despite the second-half slowdown and the rough-and-tumble of the trade dispute. In fact, trade relations might not affect the industry’s drivers: China relies on outside manufacturers for cutting-edge semiconductors because its native industry lags by years, if not decades. That gives the country’s leaders a strong incentive to make some kind of trade deal.
Overall, semiconductors continue to power the technology-based resurgence that has characterized the post-financial-crisis period. I see strong tailwinds for this industry, particularly with the advent of 5G and the ever-growing roster of connected devices. Both developments should bode well for investors with the patience to take a long-term view.
The above article originally appeared in the Summer 2019 issue of Quarterly Insights magazine.