BFI Infinity Insights: Are chips the new oil?
Semiconductors have been regularly in the news over the last few years and significant developments in their supply and demand dynamics have often had a huge impact on other industries, from the automotive sector to big tech. However, the shift that is presently underway has the potential to reshape the semiconductor market and it can offer very interesting investment opportunities to those who pay close attention.
The story so far
Semiconductors, also referred to as chips (even though technically “chip” is a blanket term for semiconductor component products), are found in countless modern electronics, such as computers and smartphones, medical equipment, or household appliances. Their distinguishing characteristic, as the name implies, is that unlike insulators or pure conductors, they can conduct electricity under certain conditions but not others, depending on how they’re designed and the purpose they’re meant serve. There are different types of chips, destined for different uses, but broadly, the four main categories: memory chips, microprocessors, commodity integrated circuits and ”systems on a chip.”
The chip industry is an extremely competitive and fast moving one, as companies constantly try to come up with smaller, faster, more efficient, more reliable products, employing new technologies to bring down the per-chip production cost. Also, unlike in the infancy of the industry where companies would undertake the entire chip production process, today the supply side is much more fragmented and there is a much higher degree of specialization and outsourcing.
For instance, there are foundry companies, whose sole focus is manufacturing, there are extremely specialized design companies, and there are separate testing and packaging businesses too. Many semiconductor companies today, known as “fabless” (short for fabrication-less) only handle design and marketing and they outsource all or part of their manufacturing.
Although semiconductors were invented in the US, East Asia eventually became a manufacturing hub, with Taiwan emerging as the biggest producer of the world’s most advanced chips and with the Taiwan Semiconductor Manufacturing Company (TSMC) as the world’s top chipmaker. Other leading nations include Japan, South Korea, the US, and China. China in particular, thanks to extensive state investments and the massive import of crucial talent and tech, has been catching up fast over the last years.
As far as the other side of the equation goes, namely demand, while in the past semiconductor growth was linked to personal computer and mobile phone growth, today chips are essential in the production of virtually all modern electronic devices, appliances and vehicles. As a report by Accenture aptly points out, there are about 170 semiconductors in the average smartphone and anywhere from 1,000 to 3,500 in a modern car. That’s to say nothing of electric vehicles, which, according to the International Energy Agency, require almost twice as many chips as equivalent conventional cars.
Chips are what make our modern world go ‘round and a harsh reminder of that came last year, when global semiconductor shortages caused widespread disruptions in multiple industries that depend on them. The “great chip shortage” was triggered by the lockdowns and the forced business closures that were enforced during the pandemic and hit Asia particularly hard. The lockdowns also had an impact on demand, as remote work meant that the need for more laptops and smartphones skyrocketed, creating a perfect storm.
Apart from this “covid shock”, however, there were also multiple other factors and various structural issues that rendered the sector relatively fragile and vulnerable to such a scenario. As S&P Global highlights, “Over the last decade, the market has seen many businesses moving toward just-in-time inventory strategies. This is cost-effective and efficient when the supply chain is without shortages, because a just-in-time system saves businesses on inventory storage space and costs as they reduce their supply chain inventory. Consequently, businesses depend on factory capabilities to accurately increase and decrease production based on their forecasted orders and inventory pipeline.”
The big shift
While the worst is over, for now, in the chip shortage crisis, there are other important developments that investors need to pay attention to. Beyond the vulnerabilities that the shortage exposed and the clear realization that as technology advances, the need for more and more chips will be inevitable, more recent geopolitical events served as fresh reminders of how essential it is for a nation to be “chip-independent”. It became clear that it’s not just securing the chips that is important, but one must also be strategic about who supplies them. Much like“energy-independence”, semiconductors took on a wider role, and the control over and access to them eventually came to be seen a national security concern by a growing number of countries.
The war in Ukraine and China’s “special relationship” with Russia, as well as the ever-intensifying frictions between China and Taiwan, gave rise to serious fears over future chip supply and motivated the US political leadership to take action to prepare for worst-case scenarios. The CHIPS (Creating Helpful Incentives to Produce Semiconductors) and Science act, passed last summer, is meant to boost American semiconductor producers and it provides $280 billion in new funding over the next ten years in various subsidies to domestic chipmakers. This represents one of the biggest steps so far to onshore and reshore chip manufacturing and the US isn’t alone. The EU is also trying to support its own chip industry, with the proposed European Chips Act, Taiwan recently offered tax credits to its chipmakers in order to maintain its technology leadership, while Japan and South Korea also provided their own incentives.
Apart from direct support to domestic manufacturers, however, countries are also trying to band together to reduce their reliance on China. The “Chip 4 alliance”, comprised of the US, Taiwan, S.Korea, and Japan, is a proposed semiconductor supply chain alliance. In- troduced last year, it represents an effort by the US to unite forces with its East Asian allies to counter the regional superpower and cut off its access to the tech needed to produce advanced chips. Further- more,aftertheUSalreadybannedtheexportofchips, chip-making equipment, and software containing US tech to China, it also secured deal in late January with the Netherlands and Japan to restrict exports ofadvancedchipmanufacturingmachinerytotheir common adversary.
The bullish case for semiconductors in general is rather clear cut, with a number of mega trends aligning in its favor. Demand for chips is set to keep growing, as technical innovations in the indus- tries that need them move apace. The global push for the mass adoption of EVs, as part of the fight against climate change, might or might not be suc- cessful, but for the foreseeable future, EV makers will continue to gobble up twice as many chips as their internal combustion engine (ICE) peers do.
Other “green” initiatives and renewable energy producers are also set to play a growing role in pushing up demand, as both solar panel systems and wind turbines are highly dependent on semiconductor technology. AI applications, most recently capturing public attention due to the impressive ChatGPT, are another clear and imminent epicenter of demand, as are the perpetually advancing industrial robots and other automated equipment. According to a recent report by McKinsey, “the global semiconductor industry is poised for a decade of growth and is pro- jected to become a trillion-dollar industry by 2030”.
The most straightforward way for investors to take advantage of the semiconductor industry’s expected growth is the “pure play” approach of investing directly in chipmakers. Another interesting investment approach is to focus on chip-making equipment, instead of the end product itself. Overall, Asia might still be leading the semiconductor race at present, but solid, resilient companies can be found in the West as well, and given the recent moves by the US and Europe, that could be increasingly true going forward.
This report was prepared and published by BFI Infinity Inc., a Swiss wealth management company registered under the U.S. Investment Advisors Act of 1940 with the U.S. Securities and Exchange Commission (SEC) as an investment advisor.
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