In Y2K, Asia Poses a Problem for Fabless Semiconductor Makers

Could fabless semiconductor companies, with manufacturing plants throughout Asia, be at great risk for Y2K failure?
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SAN FRANCISCO -- Semiconductor investors love "fabless" companies, those chip makers that send out the fabrication or manufacture of chips to subcontractors, preferably in low-cost labor areas of Asia. But when it comes to the year 2000, these plant-less companies may find themselves product-less.

The nice thing about subcontracting the manufacturing is that in economic downturns, fabless companies don't have to spend money to prop up empty plants. The downside is a lack of control over production, and come Dec. 31 of next year, those who lack control over their manufacturing processes could find themselves with nothing manufactured.

We're talking about companies like

PMC-Sierra

(PMCS)

, whose stock is trading just off its all-time highs.

Semiconductor plants come in two varieties: company-owned "fabs" and subcontracted "foundries." While most of the fabs are in the U.S., most of the foundries are in Asia. And Asia raises Y2K red flags throughout the semiconductor industry.

Just consider the steps the U.S. manufacturers are taking in their own plants. At

Texas Instruments

(TXN) - Get Report

, Y2K program chief Karla Barber said the company has tested thousands of pieces of equipment since beginning its compliance program in 1996. Since manufacturing systems are so integrated, a date problem with one piece could cause defects in all the chips the plant produces.

As of October 1998, after spending $50 million, TI had made just 60% of its operations Y2K-compliant. Barber is less confident about subcontractors. "It is an arm's-length communication," she says. "Their equipment testing is their responsibility."

Chip companies express almost universal concern about compliance in Asia.

Intel

(INTC) - Get Report

is spending some $250 million to make itself Y2K-compliant here and worldwide, and it says it is testing every piece of equipment, every product made and every software system used in the company. But even its Y2K spokesman Bill Calder says the company isn't counting on smooth operation of its own Asian plants. Indeed, he compares Y2K's potential effect on Asia to an earthquake.

"The only thing you can do is really provide for the slack to be picked up by an unaffected site," he says. "It's why we don't have 15 fabs in Silicon Valley -- because we discovered that Fab 2 in Livermore is right in the middle of a fault line. That's how we got started in Oregon."

The fabless companies, like PMC-Sierra, that depend on Asian foundries don't have this capability or Intel's enormous resources. And even more worrisome, they also seem to lack the same level of concern.

In PMC's

SEC

filings, the company offers a terse 250 words on Y2K preparations. And what of manufacturing subcontractors? Even less is said.

"The company believes that many of its suppliers and customers have not completed their own systems modification to be year 2000 compliant," the company reported in its latest 10-Q. "The company has received written communication from its critical suppliers that they have developed an action plan to address the issues related to the year 2000. The failure of significant suppliers or customers of the company to become year 2000 compliant could have a material effect on the company. Those consequences could include the inability to receive product in a timely manner or lost sales opportunities, either of which could result in a material decline in the company's revenues and profits."

How big a problem is Asia?

Etec

(ETEC)

Chief Information Officer Don Lima says the company is planning to arm all its sales and servicing offices with satellite phones because the company isn't expecting a dial tone out of Asia for weeks into 2000.

"It was a challenge coordinating the efforts of our foreign offices," Lima says. "They didn't have the same literacy of the Y2K situation. They didn't truly understand the potential impact of the problems."

Any company dependent on Asian subcontractors should be worried, Lima says. Y2K experts in other chip companies and equipment makers echoed Lima's and Calder's concerns about equipment failures in Asia. The consensus is that the governments and companies there seem far behind on the Y2K needs. And chip-manufacturing systems are so complicated that the clock has already run out. "If you haven't started now," Calder says, "it's too late."

Now the largest Asian foundry operator

Taiwan Semiconductor Manufacturing

(TSM) - Get Report

has been working on its Y2K kinks since December 1997, says spokesman Charles Byers. He expects the company to have all systems and equipment converted and audited for compliance by June. But TSM holds 43% of the foundry market there, leaving 57% of production in the hands of smaller operators.

And let's not pick on just PMC-Sierra. There are a whole slew of fabless companies -- communications chip maker

TranSwitch

(TXCC)

, graphic chip maker

NeoMagic

(NMGC)

and networking chip maker

MMC Networks

(MMCN)

as just a few examples. NeoMagic spokeman Mark Singer says the company is working on developing contingencies, such as stocking extra inventory and developing alternate suppliers.

A spokeswoman for the Dallas-based

Fabless Semiconductor Association

, which has 48 members, said that Y2K wasn't a major concern with the membership. She also told us to check back in six months.

Maybe she didn't realize the Y2K issue is date-sensitive.