Intel (INTC) and ARM Holdings (ARMH)

chipmaking rivalry

The big division in the chip-making industry over the past 15-20 years has been between giant vertically integrated makers like INTC, Texas Instruments … which manufacture chips designed in-house and smaller digitally-oriented design firms who rent structural intellectual property from ARMH, modify it and have chips made in third-party contract fabrication factories like those run by TSMC.

INTC’s advantages have been the raw power of its chips and its manufacturing superiority.  Users of the ARMH framework tout the elegance of their designs that enables output to be smaller, use less electricity and generate less heat.

disruption by iPhone

The balance of power began to shift away from INTC and toward the ARMH camp when INTC decided not to make chips for the iPhone.  It may be that INTC management thought smartphones were a flash in the pan, as urban legend has it, or it may simply have been that INTC knew its chips ran too hot and used too much power for Apple to be satisfied with them.  In any event, INTC has been trying to reinvent itself since then, by improving its chip design while maintaining its manufacturing edge.

On the latter front, INTC continues do well; on the former, not so much.  Despite a lot of design effort, its low-power, low-heat solutions for the smartphone world haven’t been good enough to gain much traction.

This itself threatens the manufacturing operation.  As INTC steadily shrinks the size of its chips, each silicon wafer processed becomes capable of yielding more output.  At some point, INTC’s factories are potentially going to be capable of churning out more chips than the company can reasonably expect to sell to its PC and server customers.  The capital equipment used in chip making is so expensive–$3 billion+ today, maybe $10 billion+ for the fabs of a few years from now–that the factories have to run at high utilization rates to be profitable.  INTC has already said that next-generation (extreme ultraviolet lithography) technology is too expensive for even INTC to invest in by itself.

Hence the deal with ARMH.

three other points:

–presumably working with ARMH-based firms will help INTC fine-tune its manufacturing processes for mobile and the Internet of Things

–this may be the first step in closer cooperation between the two companies

–the arrangement has been announced very quickly after Softbank agreed to acquire ARMH.  Are the two connected?  If so, Masayoshi Son may have plans for much greater integration of the two rival firms.

 

 

 

 

Intel (INTC) and ARM Holdings (ARMH)

At its Developer Forum yesterday, INTC announced that it is opening its cutting-edge fabs to manufacture chips that employ ARMH designs created by third parties.  So, as at least part of its business, INTC intends to become a foundry like TSMC.

(An aside: despite its glitzy style, it’s much harder to find information about the move on INTC’s website than on ARMH’s.  I don’t know whether this has any significance, but it’s the sort of odd fact that rattles around in a security analyst’s head until an answer can be found.  Is it me?  Is INTC more interested in sizzle than steak?  Is INTC’s IR effort still mired in the mindset of the former regime?…)

I’m not sure what the total significance of this move is, but at the very least:

–TSMC, the premier foundry, a Taiwanese company, trades at about a 17x price earnings multiple.  INTC now trades at about the same PE, although it has typically traded at a lower rating than TSMC in the past.  In contrast, ARMH trades at about 70x, a PE that I think must be unsustainably high, even though ARMH has managed to do so for years.

For my money, INTC’s fabs are better than TSMC’s.  Making loads of ARM chips for others will likely not lower INTC’s pe ratio.  Arguably, as the foundry business expands, INTC’s pe will rise.

–in every generation, the size of chips shrinks while the cost of a next generation fab rises. As a result, the amount of output that a fab must have to be able to operate profitably increases, while the penalty for having too little output goes up as well.

The ARMH partnership signals, I think, that INTC believes that to maintain its manufacturing edge, it must accept manufacturing orders from outside parties.

 

More tomorrow.

 

 

 

 

Intel (INTC) and next-generation semiconductor plants

We’re living in a time of immense structural change.  For investors, the internet-led waning of established brand names and bricks-and-mortar distribution networks and the loss in value of existing manufacturing plant and equipment as new factories spring up in developing countries are among the most important.

One exception to this trend has been in semiconductor production.  There the engineering knowhow required to run the factories is very high and the pace of change has been very swift.  In addition, the cost of building a new fab is prohibitive for most:  a current-generation plant costs about $3 billion.  If a firm wants to fill the plant exclusively with its own chips, that requires annual sales of $7 billion or so.  In other words, only INTC and Samsung are big enough and rich enough to afford their own plants and the technological edge that brings.  Everyone else has to use third-party contract foundries like TSMC.

INTC currently has maybe a two-year lead over other semiconductor manufacturers in process technology.  It can make smaller, faster, less power-hungry chips than anyone else.  To preserve this advantage, the company has been making preparations–including funding research by equipment manufacturer ASML–to be the first out of the blocks with plants running new “extreme ultraviolet” technology and processing much larger silicon wafers to boot.

What has come to light very recently, however, is that these new factories are going to be mega-expensive, at $10 billion apiece or more.  As things stand now, that makes building one of them a bet-the-company move for anybody, even an industry giant like INTC.

Where to from here?

It’s not 100% clear, to me anyway, but:

–extreme ultraviolet lithography is probably at least a half-decade away, not a 2017 event as previously thought.  This means R&D and capital spending will be spread over a much longer period of time.  All other things being equal, this will mean higher cash generation by INTC.

–absent a significant cost-reducing breakthrough in EUL, INTC will likely partner with at least one other party to fund a next-generation fab.  Partnering could either be with other chipmakers or with one or two large deep-pocketed users of chips.   …AAPL?  …MSFT?

–it’s conceivable that INTC will itself end up with a substantial foundry business manufacturing chips designed–at least in part–by third parties.  One might argue that this would be a come-down for the premiere manufacturer of proprietary microprocessors.  However, the best foundry, TSMC, trades at a substantial PE premium to INTC even though its technology is inferior.  So morphing into a foundry could easily add a quarter or a third to INTC’s stock price.

TSMC’s 28 nanometer problems: significance

Rumors have been swirling for some time in tech circles about difficulties the Taiwanese foundry, Taiwan Semiconductor Manufacturing Company (TSMC), is having in bringing its latest cutting-edge chip fabrication lines into full production.  The stories were confirmed when QCOM warned in its latest earnings conference call that over the next quarter or two it would be unable to supply customers with all the most advanced chips they wanted. (Interestingly, in its quarterly earnings call, AAPL said it would be unaffected because it isn’t using 28 nm chips.)

Why is this important?

background

1.  For many semiconductor chips, the history of their manufacture is one of constant attempts to make more complex and faster speed, but also smaller, less power-hungry and cooler output.  One of the main ways of accomplishing all but the first of these goals has been to shrink the spacing between the lines of the chip patterns written onto silicon.

2.  A nanometer is a billionth of a meter.   The 28 nanometer spacing that TSMC is having trouble with is, therefore, a distance between lines of 28 billionths of an inch.

3.  About twenty years ago, the foundry–or third-party manufacturing–business began to come into prominence, as several positive factors for that industry converged.  The increasing complexity of semiconductor “fabs” meant that it cost $3 billion to build one.  Even worse, a fab churned out $7+ billion in output, far beyond the sales of all but the largest companies.  At the same time, a generation of ambitious chip designers wanted to break away from stodgier established firms and develop chip designs on their own. Many focused on customizing templates provided by ARM Holdings (ARMH).

4.  The unquestioned leader in the foundry arena is TSMC.

a paradigm shift in the offing?

There are two big integrated semiconductor designer/fabricators left–INTC and Samsung.  Neither is having fabrication problems.  INTC is beginning to produce 22nm chips in volume, and promises 14 nm for 2013.  In addition, it is using a new production technique that it calls “3-D,” that gets an unusually large benefit from its current linewidth shrink.  Most important, in my view, is that the company seems increasingly concerned with providing customers with products they want, rather than just the latest engineering tour de force.

Samsung already provides foundry services to others–it builds many AAPL chips, for example.  And INTC’s mammoth capital spending campaign of 2011-12 has analysts asking–and the company denying–that it intends to offer similar foundry services in the future.

my thoughts

ARMH, which has–with justification–been an immense market outperformer as the one-stop-shopping way to play the mobile device chips that the design firms/foundry model has been churning out.  But the stock (at 55x historic eps) is down about 20% over the past year, a time when INTC shares (12x) is up by 25%.  Over the same period, Samsung Electronics (5930.KS) (15x) is up 50%.

Yes, the issue with ARMH may just be the high PE multiple.  And, yes, Samsung isn’t just chips.  It’s a force in smartphones and dominant in TVs.  And it trades in a market that marches to its own drummer.  But I think the market is saying that the old integrated model has more going for it than the consensus appreciates.  I also think the market is right.

TSMC’s fabrication difficulties may be the trigger that gets a wider group of investors to focus on the change.