Malcolm Penn: “We Are Stoking Capacity Just When We Don’t Need It”

On Tuesday this week, Malcolm Penn of Future Horizons gave one of the three annual presentations on the outlook for the semiconductor industry. I last wrote about a presentation by Malcolm what feels like "recently" but was, in fact, in 2021. That post was called Semiconductor Numbers Everyone Should Know. Malcolm founded Future Horizons back in 1989, and has been following the semiconductor industry for even longer and, as he puts it, he has seen every semiconductor upturn/downturn cycle except the very first back in the 1960s. At some level, his fundamental approach is that there are certain constants in the semiconductor industry and the industry never drifts far from these numbers before they return, and this has been true for 50 years. I won't repeat everything that is in that previous post I just linked to above, you should go and read it if you have not seen it before. More on that later.

Cycles and Drivers

Meantime, here is the historical record. The 2021 boom and 2022 shortages were predictable and nothing special. This was #16 with 15 previous upturns since the first cyclical downturn since 1961. The 10 previous booms were actually stronger (such as +31.8% in 2010, or +28% in 2004, and so on).

So what about the 2022 crash and the 2023 downturn, which were also "normal" (per Malcolm). This was the third consecutive year of positive industry growth. The 1H-2021 CapEx spend accelerated in 2H-2021. Industry has not had a shortage/bust since the 2000 dot.com boom. This means that any executive under 40 has never lived through a classic boom-bust cycle.

So how does it work? The big problem is that 

Demand can change very rapidly (up and down) but capacity can’t. It is three years for a greenfield fab so there is a need to invest counter-cyclically.

So there is a need to keep track of the current status versus the underlying trend, and if there is a difference, a correction is inevitable. Can be both up or down, of course. So where are we today?

• Economy: Determines what users can afford to buy, the more buoyant the stronger the demand
• Unit demand: Reflects what users actually buy (plus/minus inventory adjustment)
• Capacity: Determines how much demand can be met (can be over or under supplied)
• ASPs: Sets the price that units can be sold for (which is a mixture of supply/demand and pricing power)

Let's look at each of these four trends individually.

• Economy: "Clouded in fog and uncertainty". Market downturn, energy costs, inflation, interest rate rises, global recession, regional conflicts and political tension, trade sanctions, regional semiconductor investments. Bottom line is that the chip market needs a strong economy to flourish.
• Unit shipments: These are way above the long-term average (see the graph). Actual shipments are 7.8B per week. Real demand is 7.0B per week. So ~10% above trend. Two to three more quarters before balance is restored.
• Capacity: CapEx is running rampant and so "we are stoking demand just when we don't need it". In October, CapEx was almost 20% of semiconductor sales (and that is down from September when it was nearly 22%). It takes a minimum of four quarters to rein in CapEx when no longer needed.
• ASPs: "The rout is now in full swing". Q3-2022 ASPs were back to Q1-2021 trough, so the past six quarters of strengthening prices are no gone and ASPs will drift towards cost, so long as there is industry overcapacity.

It doesn't get much worse than this since every one of the four trends is flashing red. The big headwind is that increase in capacity is coincident with softening market demand, in particular we have a gloomy economy with high inflation and high interest rates.

Forecast Is -22%

Here are the top 2023 driving influences. Gordon Moore is known for Moore's Law of course, or what Malcolm calls Moore's First Law. But there is also Moore's Second Law (which I thought was that he said the cost of a fab doubles every four years) but Malcolm's definition is Moore's prediction that eventually the cost of any IC eventually reaches one dollar. But, as Malcolm says, "nobody likes that law so we never talk about it".

Firstly, don't place all the blame on memory:

It's everything. First it is memory, which is the most commoditized, then microprocessors which are partially commoditized, and finally logic, which is barely commoditized since it is all SoCs. And it has always been like that.

So the number we've all been waiting for. Malcolm's growth number for 2023 is -22%. That is, 2023 will be down 23% from 2022. The bullish upside number is "only" -17%, and the bearish worst-case is -26%. This is unchanged from Malcolm's predictions from May 2022.

The forecast summary is:

• 17th industry down cycle now in full flow
• No change from 2022 forecast, 2023 growth is still -22%
• Worsening economic outlook will likely prolong the downturn
• Industry only now (finally!) acknowledging 2023 with be negative but still in denial about the magnitude
• It's never "different this time"
• Double down on R&D and invent your way out of the problem
• It's time to start preparing for the next upturn now (you have to invest counter-cyclically) and get first mover advantage

 

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