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Simply Can't Conduct Business as Usual

Semiconductor firms are still assessing the damage after the disaster in Japan.

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There is little doubt the tragic earthquake and tsunami in Japan last month (as well as any further aftershocks) will have macroeconomic effects that will hamper semiconductor demand in the country. Assessing the extent of the damage is still an ongoing process, and the final tally likely will take months to sort out. Perhaps the first attempt to size up the damage came from  Taiwan Semiconductor (TSM), the global leader in outsourced chip manufacturing, which cut its forecast for global semiconductor growth in 2011 to 4% from 7% (excluding memory chips). We should be able to gain additional insight from a host of first-quarter earnings conference calls from chipmakers in mid-April, but in the meantime, we've summarized our initial thoughts concerning the damage.

Japan's Role in Semiconductor Supply and Demand
Japan is one of the bigger consumers of semiconductors and is home to many electronic device makers, including  Sony (SNE) and Nikon. Aside from the country's fewer purchases of electronics and other goods that contain chips, such as PCs and smartphones, Japanese electronics makers have seen manufacturing stoppages due to both structural damage to their facilities and consistent power outages in the region, which likely will cause a near-term decline in new chip orders. Further, many chipmakers, especially analog firms, are suppliers to Japan's automobile manufacturers, which also have seen production stoppages. Thus, chipmakers across the board likely will see lower near-term demand. Companies with notable exposure to Japan include  Linear Technology (LLTC) and  Analog Devices (ADI), which each generate about 15% of their sales from the country, and  Intel (INTC), with roughly 10% of its revenue from the region.

On the supply side of the equation, Japan is home to many semiconductor firms and chip fabrication plants which were interrupted by the disaster.  Texas Instruments' (TXN) plant in Miho contributes about 10% of the firm's total revenue, but was knocked off line and production won't resume until mid-April; full production won't resume until mid-July, and full shipments won't occur until September. Texas Instruments' digital light projector (DLP) devices are made in Miho, and although they account for less than 5% of TI's revenue, the business is dependent on springtime production, as these projectors are ultimately sold during back-to-school season. An article from Taiwanese trade publication DigiTimes indicated that TI's Miho plant also produced controller chips for motors in hard disk drives (HDDs), and if the HDD supply chain were to be disrupted, other chipmakers such as  Marvell (MRVL) and  LSI (LSI) also may suffer in the near term.

Privately-held Renesas, another key chipmaker and Japan's largest microcontroller (MCU) manufacturer, still has one fabrication plant knocked out by the damage and is suffering from lesser damage and power outages at seven other plants. One firm that might be able to take advantage of Renesas' misfortunes is U.S.-based  Microchip Technology (MCHP), which already had been gaining share from Renesas in the 8-bit MCU market before announcing a flood of new MCU orders after the quake.

Unfortunately, bigger problems for the semiconductor industry might be found further down the supply chain with the raw material suppliers. Mitsubishi Gas Chemical is a primary producer of a specific resin used in chip packaging, but the company won't be running at full capacity until May. A variety of chipmakers that outsource the packaging function to third parties could see indirect supply interruptions. Also, Shin-Etsu Group and Sumco Corp, two large suppliers of silicon wafers--the main raw material used in chip manufacturing--currently are knocked out by the disaster. Ultimately, chipmakers with little to no manufacturing or customer presence in Japan may be forced to cope with raw material shortages and supply chain troubles as well.

Memory Chips: Shortages May Lead to Higher Prices
There also have been disruptions to the production of computer memory (DRAM) and NAND flash memory chips, which already have materially affected the supply and pricing in both of these markets.  SanDisk (SNDK) and Toshiba, which have joint venture NAND flash memory manufacturing plants in Japan, reported that both of their NAND fabs were shut down for a brief period because of the earthquake. The SanDisk/Toshiba joint venture accounts for about 35% of flash memory production, so the incident likely will have a substantial affect on industry supply. Although operations have resumed, any disturbances to a fab, even a small one, can have significant effects on output. For example, a very short power outage in December caused a Toshiba/SanDisk fab to lose 20% of production and precipitated a 3%-11% increase in flash memory contract prices, according to DRAMexchange.

The earthquake already has caused NAND flash memory prices to rise in anticipation of supply constraints. DRAM pricing also increased after Japan's only computer memory producer, Elpida, suffered a power outage after the earthquake that disrupted production at one of its manufacturing facilities. Elpida's market share in the DRAM space is roughly 10%, according to  Micron (MU). The higher pricing for DRAM and NAND flash memory should benefit other major memory players, such as Micron, Samsung, and Hynix (all three supply NAND and DRAM), as these firms don't have fabs in Japan and will be able to capture additional business in the near term.

Semiconductor Equipment: Order Delays on the Horizon?
Not surprisingly, we also expect the semiconductor equipment industry to see some effects from the disruptions being seen at Japanese chipmakers. According to estimates from IC Insights, capital spending from Japanese chipmakers (we include U.S.-based SanDisk because the firm's only fabs are in Japan) had been expected to account for about 12% of total semiconductor industry spending in 2011, which isn't too substantial. While we now expect to see lower capital expenditures from this group for the year, we think semiconductor equipment demand from Japanese chipmakers more likely will be delayed rather than reduced. For example, the big Japanese fab project from Toshiba/SanDisk, Fab 5, was expected to come on line this summer. However, given the disruptions all over Japan, we believe the firms will have to finish the fab at a later date.

In addition, some chipmakers will need to replace damaged equipment in their manufacturing plants, which could be a benefit to semiconductor equipment companies like  Applied Materials (AMAT) and  KLA-Tencor (KLAC). In the last three years, sales to Japan have ranged from 7% to 13% at Applied Materials and 13% to 29% at KLA. While Japanese chipmakers sometimes prefer domestic semiconductor equipment suppliers, major U.S.-based companies do have significant presences in the country. There have been reports of interruptions at some Japanese chip equipment firms, including at Tokyo Electron, which could result in more business for U.S. and other foreign-based companies. Gigaphoton, the smaller firm in a photolithography light source duopoly with  Cymer (CYMI), has suffered major disruptions to its operations, which could benefit Cymer in the near term.

Are There Any Rays of Hope?
Surely, no chipmaker will declare itself a winner from the tragedy in Japan, especially with the extent of supply chain interruptions and the potential decline in Japan's GDP still to be determined. Yet we still see the possibility of some firms losing out much less than others. Chipmakers that might be able to capitalize on an improved pricing environment or a competitor's misfortunes, such as Micron or Microchip, may see a near-term boost in revenue. Also, the massive rebuilding efforts needed in Japan may spur the purchase of infrastructure and electronics with higher silicon content per device. Corporations that have to replace damaged PCs and servers will be forced to upgrade to products that may include Intel's latest line of processors, for example. Similarly, car owners who lost their vehicles may look toward hybrid and electric cars, which have greater silicon content and could drive longer-term chip demand for a host of analog chipmakers. Nonetheless, we're still in wait-and-see mode with the semiconductor industry, and we think it would be reckless to get extremely bullish about most chipmakers' near-term prospects without considering the tragedy in Japan.

Andy Ng and John Ayling contributed to this article.

Brian Colello does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.