The history of semiconductors dates back to the 19th century, marked by Karl Ferdinand Braun’s discovery of rectification in 1874. Practical applications then emerged in the early 20th century, such as the cat’s whisker detector, a rudimentary semiconductor device used in early radio receivers. This device consisted of a thin wire, or ‘whisker’, that made contact with a semiconductor crystal, such as silicon, to detect and convert electrical signals into audio signals.
Since its inception, the industry has been characterised by cyclicality as well as its relentless pursuit of innovation, defined by Moore’s Law, which states that the number of transistors on computer chips double every two years with little change in price. Of course, the industry has come a long way since those first primitive semiconductors and their applications, and continuous advances have given way to semiconductors so sophisticated that they have become indispensable to the functioning of modern society. The industry’s rapid evolution is reflected in its staggering growth, with annual sales quadrupling in just two decades - soaring from $139 billion in 2001 to $573.5 billion in 20221. This rapid growth is well illustrated by the development of ASML’s market capitalisation below.
Most recently, the semiconductor industry has faced global supply chain disruptions, triggered by the Covid-19 pandemic. While some sectors, notably automotive, faced reduced orders, most, such as consumer electronics, saw unprecedented growth due to the shift to remote working. US sanctions on companies with ties to China, combined with factors such as the 5G rollout, the Russia-Ukraine war and severe weather events, added to sector volatility. Semiconductor manufacturers responded to heightened demand during the pandemic by increasing inventories, supported by government subsidies. However, the end of the consumer electronics replacement cycle resulted in an industry slowdown in the latter half of 2022 and excess chip inventories.
A year later, inventory levels stabilised, particularly in the global IT components sector, marking a turning point in the cycle. TSMC’s revenue, a key indicator of industry health given they manufacture around 90% of the world’s advanced chips, rose by 14.4% in Q4 2023 from the previous quarter2. Some concerns persist regarding oversupply, especially for foundational chips, as Chinese chipmakers continue to increase production. Nonetheless, the industry is expected to maintain its upward trajectory, with sales revenue estimated to reach between US$588-613 billion in 2024, surpassing 2022’s record of US$574 billion, and 2027 forecasts come in around US$736.40 billion3.
The global shortage of semiconductors provided a wake-up call for many governments, particularly in the US and Europe as it served to highlight the vulnerability of over-reliance on the global supply chain. In response, governments began efforts to de-risk their supply chains through onshoring and nearshoring production. This trend has proved beneficial to some players in the supply chain as the total addressable market for existing suppliers increases in line with an increase in capacity and production. For example, Park Systems, which supplies wafer inspection equipment, is benefitting from the increasing demand of smaller nodes and the corresponding expansion of manufacturing lanes.
The US government’s 2022 CHIPS Act is a prime example of efforts to onshore. It allocated $52.7 billion4 in federal subsidies to support domestic chip R&D, manufacturing and workforce development. Just recently, President Biden announced up to $8.5 billion direct funding to US chipmaker Intel under the CHIPS Act to fund new chip plants in the US.
The US government-imposed restrictions on the export of advanced chips and chip manufacturing equipment to China in October 2022, and tightened the restrictions in November 2023. The move was intended to pre-empt the prospect of Chinese global dominance in the industry, as the Chinese government also sought self-sufficiency. However, the move has yielded mixed results. While it has hindered China’s progress in advanced chip manufacturing and AI development, leading to a focus on foundational chip manufacturing instead, it has likely accelerated China’s path to self-sufficiency by making this an even higher priority for Beijing and forcing Chinese companies to be more innovative in order to develop their own advanced chips. For example, in October 2023 Beijing announced a $40bn state-backed fund to boost the semiconductor sector, and at the same time, scientists at China’s Tsinghua University announced the development of the world’s first fully system-integrated memristor chip in October 2023, with significant applications in AI and autonomous driving5.
In 2024, the consumer electronics sector is poised for solid growth with a forecasted 3.5% and 4% increase in PC and smartphone sales respectively according to Gartner. This upswing is fuelled in part by a new notebook renewal cycle, as well as a wave of smartphone replacements driven by on-device AI, which allows smartphones to process data within the device rather than on a remote cloud server; this reduces security issues and enables AI services without internet connection. This development, we believe, will benefit a number of our portfolio companies that cater to this industry. One example is Elite Material, a key supplier of high-density copper clad laminates, a crucial component used in advanced chip production. Another example is LEENO which is set to see higher revenue growth in 2024 given their significant R&D exposure to on device AI.
NVIDIA’s recent Q4 2023 report of a 265%6 increase in quarterly revenues from one year ago serves as a prime example of the substantial growth AI can drive, with CEO Jensen Huang asserting that AI has reached a ‘tipping point’. The seemingly limitless potential of the AI revolution will sustain growth in the semiconductor industry for years to come, benefiting well established companies like NVIDIA and Arm, as well as lesser-known businesses in our portfolio that cater to such industry giants.
Within the semiconductor industry, eMemory, a world-leading IP provider to over 2,400 foundries, IDMs and fabless companies, is a prime example of the type of company we like to invest in, with deep moats, sound balance sheets and a strong outlook based on sustainable growth and expansion. In a recent quarterly earnings call, chairman Charles Hsu summarised their strong growth potential: ‘‘Our total addressable market will increase as the world expands foundry capacity and move toward more advanced technology. Our technology coverage in each foundry will increase as more technology processes develop and more fabs are established.’’ To this end, the company has several advanced 3/4/5nm semiconductor projects underway and has successfully licensed its 3nm OTP and PUF technology to a US foundry customer with whom it will work to develop the most cutting-edge processes. In addition, the royalty income for each foundry is increasing, as is the demand for licensing, resulting in increased licensing income, all of which increases eMemory’s profitability.
The promising outlook for eMemory, which will very likely profit from both increasing semiconductor capacity and complexity, is reflected in the positive outlook for many of our other portfolio companies. For example, LEENO, (see Company Spotlight in our Q1 2024 Manager's Commentary) should be benefiting from the increasing complexity of chips, which require more advanced pins and sockets for testing in the R&D phase.
The expanding total addressable market of semiconductor end markets, facilitated by this expansion in semiconductor capacity and complexity, suggests we may come to see a potential reduction in the industry’s cyclicality. The industry may become increasingly shielded from the vulnerabilities associated with single market trends with dampened demand in one sector likely having a less pervasive effect on the overall semiconductor industry and its supply chain. Furthermore, many of the new end markets, such as automotive, industrial automation, 5G infrastructure, AI and cloud computing, have larger chip demands per unit compared to those associated with consumer electronics. The outlook for the semiconductor industry is positive, not just for 2024, but for the next decade. Despite historical peaks and troughs, the industry’s overarching trend is one of exponential growth, with forecasts pointing to a milestone of $1 trillion in market revenues by 2030.
At MCP, we avoid trying to time each cycle perfectly and instead focus on identifying highly innovative companies that are positioned to benefit from the industry’s long-term trends, such as eMemory. This strategy does not begin and end with the semiconductor industry, but extends to all the industries in which we invest. In this way, we aim to create long-term, sustainable value for our investors.
To find out more about portfolio manager Carlos Hardenberg’s and the MCP team’s insights into the semiconductor industry, listen to Decoding the Semiconductor Industry. This episode is part of our new podcast channel, Insiders and Outliers - MCP on Emerging Markets. Monthly episodes are available on Spotify, Apple Podcasts and Soundcloud.