||New York, NY — Even though many analysts are projecting growth for the global semiconductor industry in 2014, structural challenges in the industry could threaten many companies, as more than half of 191 of the industry's publicly-listed companies face the risk of possible financial distress. As a result, the industry could see more consolidation, including mergers and acquisitions this year, coming on the heels of recently-announced deals such as those involving Avago Technologies and LSI, Micron and Elpida Memory, and Applied Materials and Tokyo Electron. That's according to a new study from AlixPartners, a global business advisory firm.
Underscoring what is also a bifurcated trajectory in the industry as it enters 2014, the AlixPartners study finds that in the 12-month period ending with the third quarter of 2013 the five largest companies in the industry — Intel, Qualcomm, Taiwan Semiconductor Manufacturing Co. (TSMC), Texas Instruments and Hynix — produced almost a third (30 percent) of industry revenues but over half (52 percent, or $50 billion) of industry EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). The study also finds for that same period that average EBITDA margins for the top five companies, at 41 percent, were over two-and-half times the average (16 percent) for the other 186 companies, and that 44 percent of the 186 companies saw EBITDA margins of 10 percent or lower, a level that could be a harbinger of potential cash-generation problems going forward.
As a result of these and other trends, the study finds that no less than 53 percent of the companies in the industry as a whole face the risk of possible financial distress — and that 32 percent of companies are at "high risk."
"Though the popularity of end-products such as smartphones, tablets and pads is a rising tide lifting many boats in the semiconductor industry today, the industry as a whole faces persistent structural problems," said Karl Roberts, managing director at AlixPartners and co-lead of the firm's global TMT (technology-media-telecommunications) Practice. "In many corners of the industry revenues and profits have been flat or declining for some time now, just as the demands for more spending on research and development have been escalating more than ever."
Earnings Don't Tell it All
The AlixPartners study shows that for 12-month period through third quarter 2013, combined revenues for all 191 companies studied grew 0.7 percent (to $407 billion), combined EBITDA was up 8.9 percent (to $96 billion) and EBITDA margins increased to 23.6 percent from 21.8 percent for the previous 12-month period. Meanwhile, for the 186 tier-two companies, the study shows that even though, combined EBITDA grew 10.0 percent (to $45.8 billion) in the 12-month period through third quarter 2013, that number still lags combined EBITDA levels in fiscal years 2010 and 2011 ($60 billion and $59 billion, respectively).
In addition, the study also shows that after fiscal year 2011, only the contract fabrication, "fabless" (companies that outsource their manufacturing), and package and test sectors saw positive revenue growth through third quarter 2013 — for all 191 companies studied. The sectors that saw revenue declines in that same period included equipment, down a whopping 15.8 percent; materials, down 8.7 percent; and solar, down 2.2 percent.
In terms of sector distress, the study finds that 100 percent of solar companies were facing potential financial distress (with 82 percent at high risk), as do 92 percent of package and test companies, 52 percent of materials companies, 34 percent of manufacturers doing their own fabrication and 32 percent of electronic components companies. Meanwhile, the sectors faring the best in this department in the study were equipment (11 percent facing potential financial distress), fabless (13 percent) and contract fabrication (25 percent) — though, the study says, the latter percentage would likely have been higher were it not for the size of sector leader TMSC.
Meanwhile, finds the study, even the five biggest companies in the industry are facing unprecedented stresses today. According to the study, in the 12-month period ending third quarter 2013 research and development spending as a percentage of revenue for those five companies, at 15.9 percent, was near its highest level in the past five years. That's on top of overhead costs and R&D spending combined rising 34.8 percent over fiscal years 2010-2012. One result, says the study: average return on capital employed (ROCE), a measure of a company's ability to generate returns from its total available capital base, for the five biggest companies in the industry dropped to 17 percent from 26 percent over that three-year period.
"Though some might call them the `Fortunate 5' compared with the relative performance of others in the industry today, size is really no protection when overhead costs are skyrocketing and returns on capital are going the other direction," said Roberts. "Add to that the fact that many think the entire industry could be entering a world in which Moore's Law is in danger of being repealed, and the reasons multiply for all companies today to avoid complacency."
The study finds that while overhead costs vary widely across industry segments, 36 companies, or almost 20 percent of the industry, spent more than 100 percent of their gross profits on overhead in fiscal year 2012. It appears from the study, based on EBITDA vs. revenue performance, that companies in the second tier of the industry could be ripe for consolidation, especially smaller, less-profitable companies.
"Even if there may not be more merger and acquisition deals this year in terms of number, there could well be more big deals as the industry grapples with its growing cost problems," said David Simon, a director in AlixPartners' TMT Practice. "Consolidation is a tried and true method of paring expenses, but on the other hand, significant cost-cutting isn't guaranteed just because merger papers are signed; that takes relentless execution of the merger itself, including post-merger integration."
The study concludes with a list of suggested actions for companies today in the semiconductor industry. They include:
- Taking an "unsentimental" review of customer and product portfolios, to reveal which customers and product lines are unprofitable when viewed on a "fully-loaded" basis (allocating fixed and non-direct, as well as variable, costs) — an approach that, according to the study, has generated 20-35 percent EBITDA improvements in other industries with significant fixed and non-direct costs such as medical equipment and telecommunications.
- Vigorously reviewing overhead staffing and spending, even in high-revenue areas, as growth can often mask needless inefficiency.
- In the supply chain, continuously evaluating the key profitability and capital levers such as asset utilization, material costs and material consumption, an approach that, according to the study, has saved 10-20 percent in operating costs and capital expenditures in other industries.
- Getting on the leading edge of potential consolidation by thinking strategically about where your company wants to be in what could be a very different-looking industry in the not-too-distant future.
"Companies and other stakeholders in the semiconductor industry stand at a crossroads today," said Roberts. "While they are certainly still in an exciting, leading-edge industry — one of the most exciting on the planet — the dynamics of that industry are changing dramatically. At the end of the day, as in any industry, basis business principles apply, and companies that apply those principles most effectively today will be the winners of tomorrow."
AlixPartners is currently working with Belgium-based non-profit research center Imec (formerly known as the Interuniversity Microelectronics Centre) to develop a cost-modeling solution to assist the semiconductor industry in efforts to improve the operational intelligence around the costs of future technology nodes.
Contact: AlixPartners, 40 West 57th Street, New York, NY 10019 212-490-2500 fax: 212-490-1344 Web: http://www.alixpartners.com