Semiconductor Growth Is Slowing

If you are like me, you have probably been amazed, and sometimes annoyed, by the proliferation of electronic devices throughout our society. Nearly everyone seems to own a mobile phone these days, Apple (Nasdaq: AAPL  ) iPods are ubiquitous, flat-screen TVs are soaring in popularity, and I seem to spend an hour every day turning off my 8-month-old son's toys -- in my opinion, he likes them just fine without the noise, although my wife disagrees. My perception, based on looking around, is that semiconductor sales over the past decade must have soared.

Well, perceptions aren't always reality, so I decided to hunt down the data and see what semiconductor revenues are actually doing. Since the industry is cyclical, it's important to look at long-term trends rather than just what has happened in the past year or two.

Worldwide semiconductor sales
The Semiconductor International Association (SIA) provides information on worldwide chip sales from 1982 through 2005 on its website. Taking a look at the data shows that there has definitely been a slowdown in the growth rate. During the years 1982 through 1994, chip revenues grew at a compounded rate of 17.9% per year. Since 1994, however, the growth rate has been much slower -- only 7.6% per year. These numbers are confirmed by market research firm IC Insights, which states that revenue growth over the 20-year period from 1973 to 1993 was 17%. From 1993 to 2003 the growth rate slowed down to just 8%. The center column of the table below summarizes the data from IC Insights.

Decade starting

Revenues

Units

1973

17%

13%

1983

17%

11%

1993

8%

9%

Worldwide semiconductor revenue and unit growth rates.

If you follow the semiconductor industry, you know that average selling prices of chips continually decline, so it is worth asking if the declining revenue growth rate is due to plummeting selling prices or slowing growth in the number of chips sold. The third column in the table presents data from IC Insights that may answer this question, but we need to define a unit first. Semiconductors are manufactured on silicon wafers with a very large number of individual identical circuits, called "die," fabricated on each wafer. Each die is generally counted as one unit, even when multiple die are packaged together. The table shows that growth in units sold averaged 13% during the decade after 1973 but slowed down to just 9% during the decade after 1993. At first blush, it looks like revenues are feeling a double whammy from a slowdown in unit growth combined with average sales price declines. However, I believe that the slowing unit growth rate is a little misleading because the new system-on-chip designs integrate many different functions on a single chip, thereby probably reducing the number of units counted in the study. For example, Cypress Semiconductor (NYSE: CY  ) makes a type of memory chip called SRAM. Cypress's SRAM business has been fizzling over the past several years because microprocessors used to require several SRAM chips. Now, though, the SRAM memory is just integrated in the processor.

Despite the declining growth trend indicated in the table, both IC Insights and the SIA expect a cyclical uptick to lift the growth rate to about 9% for the rest of this decade.

What about semiconductor capital spending?
It is also worth comparing revenue growth to growth in semiconductor capital spending. According to IC Insights, worldwide semiconductor capital spending grew at a rate of 12% annually from 1978 to 2003, although the yearly changes are spectacularly volatile. Comparing this 12% growth rate to those in the table above shows that capital spending grew at a slower pace than semiconductor chip revenue from 1973 to 1993, but has been greater than chip revenue growth since 1993. Either capacity additions have been excessive in the past decade or the cost of transitioning to smaller feature sizes is driving higher spending relative to revenue growth (or both).

While growth in chip sales is still stronger than worldwide GDP growth, average growth of 8% is probably weaker than most semiconductor investors would hope. Nevertheless, it is worth remembering that certain segments in the semiconductor industry will grow considerably faster than the overall industry. To get an idea of what areas are expected to grow quickly between now and 2009, we can dig through the SIA's latest forecast released about a month ago.

Fast-growing chip segments
SIA predicts that the strongest growth (16.7%) will come from digital signal processors used in mobile phones and other wireless devices. A big producer of digital signal processors is Texas Instruments (NYSE: TXN  ) . With a trailing-12-month P/E ratio of 19, TI may be a good company to watch in case the carnage among semiconductor stocks continues and takes the stock down further.

Next in line is flash memory, which SIA forecasts to grow at a rate of 13.7% per year. SIA doesn't separate NAND flash memory from NOR flash in its forecast, but presumably NAND flash will grow at a bit better rate while NOR flash growth will be a bit weaker.

Another relatively good grower, at 10.1%, should be the optoelectronics segment, which includes CMOS image sensors, which are used to record images in camera phones. OmnivisionTechnologies (Nasdaq: OVTI  ) is as close to a pure-play CMOS image sensor provider as you can find. Omnivision stock has been walloped during the last two months, and at the current price around $19 the trailing-12-month PE ratio is just 12. Unless this business implodes, Omnivision stock may be a steal at this level.

I also found it interesting to see where growth is expected to be anemic. SIA forecasts just 4.3% growth for microprocessor sales. This can't be good news for either AMD (NYSE: AMD  ) or Intel (Nasdaq: INTC  ) , and I may have to rethink my (admittedly small) investment in Intel.

Overall, the data from both the SIA and IC Insights paints a picture of a maturing industry. At the same time, the cost of transitioning to ever-smaller chips is going to become increasingly difficult and expensive. The slowing growth rate of semiconductor chips has me rethinking how I should value and invest in this industry.

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Fool contributor Dan Bloom owns shares of Intel and Cypress Semiconductor. He can be reached for comment at blm_dn@yahoo.com. The Fool has an ironclad disclosure policy.


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