Rapid increases in the demand for consumer electronics have spurred broad range growth for semiconductor chip manufacturers from Xilinx Inc., the world's leader in programmable logic products used in computer, peripheral, telecommunications and networking equipment, to small start-up companies such as 3Dfx Interactive, Inc. which produces 3D graphic accelerator chips for video arcade games.

In contrast to the three-hundred-pound-gorilla chip makers such as Intel and Motorola which can afford to spend billions of dollars on building new "fabs" (chip production facilities) and developing advanced chip manufacturing technology, Xilinx and other so-called "fabless" semiconductor manufacturers, outsource their chip production to semiconductor contract manufacturers, known as "foundries". Although there are over 200 "fabless" semiconductor manufacturers in the United States alone, there are only a handful of semiconductor foundry companies, which are based mainly on the high-tech island of Taiwan.

Leading the pack of Taiwanese semiconductor foundries is Taiwan Semiconductor Manufacturing Company, whose American Depository Receipt (ADR) is traded on the New York Stock Exchange under the symbol of TSM. Taiwan Semiconductor is followed by United Microelectronics Corp. (UMC) Group, Windbond Electronics Corp. and Worldwide Semiconductor Manufacturing Co.(WSMC). Other non-Taiwanese major players are the US's IBM Blue Logic Technology, Singapore's Chartered Semiconductor Manufacturing, and Israel's Tower Semiconductor which was established as a joint venture of Data Systems & Software Inc., The Israel Corporation Ltd., and National Semiconductor Corporation.

Although Taiwanese semiconductor foundries, as a group, announced a plan in 1997 to build some 30 new fabs during the next decade, the number of semiconductor foundry fabs may not significantly increase in the next few years. Dataquest, a San Jose-based research group, characterized the 1998 semiconductor foundry business as in acute oversupply. According to the Dataquest report, many semiconductor contract manufacturers cut back spending rates by 50 percent or more from the first half to the second half of 1998. 

Clark J. Fuhs, vice president and director, Semiconductor Manufacturing Analysis, for Gartner Group/ Dataquest, added "the industry will be in oversupply through at least mid-2000, so we expect the foundry suppliers to remain at current spending levels or lower throughout 1999, representing perhaps a 20 to 30 percent cut from 1998 levels."

Despite low times in the semiconductor foundry business, Morris Chang, chairman of Taiwan Semiconductor, who is upbeat on the prospective of his foundry company, continues the expansion plan on a global basis. According to Reuters, Chang is planning to break ground on a new US$1.2 billion foundry fab in Singapore within a few months. The new manufacturing plant, which is part of the joint venture between Taiwan Semiconductor, Philips Electronics, and EDB Investments of Singapore, is expected to begin production in December 2000.

Taiwan Semiconductor currently has two foundry fabs under construction in Taiwan and has over 67 percent interest in WaferTech, a US $1.5 billion newly constructed foundry fab in Camas, Washington. In our viewpoint, such massive expansion by Taiwan Semiconductor could ignite other foundry companies to follow expansion, which in turn could prolong the glut in foundry services.  As pointed out by Dan Hutcheson, San Jose based VLSI Research Inc, "If you find yourself in a hole, stop digging".

Taiwan Semiconductor, now holding a leading position in the semiconductor foundry business, could be under intense competition from their domestic arch-rivals, UMC and WSMC, particularly in the 0.18 µm technology arena. According to EE Times, Toshiba has already begun to produce initial quantities of CMOS logic and SRAMs at Taiwan Semiconductor rival, WSMC. Toshiba expects that by 2001, roughly 40 percent of its semiconductor revenue will come from chips made by WSMC, Winbond and Chartered Semiconductor foundry partners and Dominion subsidiary, a joint-venture fab with IBM, in Virginia.

We believe that the entry of IBM Blue Logic Technology as a key player, with IBM’s breadth of technology, could further intensify the competitive environment of the semiconductor foundry business. IBM Blue Logic Technology offers a broad range of proprietary state-of-the art design and manufacturing to their customers which could draw more business from competitors such as Taiwan Semiconductor and UMC. In order to compete with IBM Blue Logic Technology, other semiconductor foundry companies must be willing to invest heavily in the development of advanced chip manufacturing processes or be willing to license technology from other chip companies to satisfy their customers.           

Anticipating the continuation of oversupply and increased pressure from IBM Blue Logic Technology, we expect to see further erosion in wafer prices and ensuing profit margins of semiconductor foundry businesses. In this business environment, we suggest that the big winners would be advanced semiconductor foundries such as IBM Blue Logic Technology and fabless semiconductor manufacturers such as Xilinx.  Chip equipment manufacturers such as Applied Materials could also benefit if Taiwan Semiconductor follows through with their massive global expansion.