Semicon Plays a Game of Pick-Up Chips

Much of the focus at the chip expo will be on improving productivity and growth rates.
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Perhaps there will be strength in numbers.

After a big 2004, the chip-equipment industry has moseyed along this year, reflecting the lackluster growth of semiconductor makers.

The Philadelphia Semiconductor Index, which follows 19 semiconductor-related stocks, is flat for the year, but three of its four equipment components --

Applied Materials

(AMAT) - Get Report

,

Novellus Systems

(NVLS)

and

KLA-Tencor

(KLAC) - Get Report

-- are down between 3% and 8%, while the fourth,

Teradyne

(TER) - Get Report

, is off 30%.

With this uncertainty, 1,500 semiconductor-equipment companies will converge in San Francisco next week for a three-day trade show that will attract 50,000 attendees. The annual conference, called Semicon West, is the industry's largest.

The showcase presents the consummate opportunity for company executives to meet with customers, competitors, suppliers, analysts and investors. Although product announcements will stream out of the show, much of the action will take place away from the showroom floor. Several CEO panel discussions, investor meetings, industry updates and analyst discussions will be tied into Semicon.

Novellus President Sass Somekh says he won't see home for the show's duration, and KLA CFO John Kispert estimates he'll be busy from 7 a.m. until 10 p.m. each day during the convention. "This is a gathering where it's very efficient to meet with so many people," says Kispert.

But for investors, the biggest question facing the industry now, as always, is when the next big wave of orders will hit.

Framing that question is the chip-industry's shift in production to larger and more-efficient 300-millimeter silicon wafers from 200-mm wafers. That transition requires a new set of tools in a new factory. A state-of-the-art chip factory now costs about $3 billion -- a figure that's increasingly hard to finance for all but the largest semiconductor players and reason in part for the growing number of industry partnerships and co-development linkages.

It's also part of the reason for investor uncertainty about the equipment players, which are under increased pressure to lower costs, share development burdens and keep pace with planned technology transitions.

KLA and the Chip Factory

KLA, the world's fifth-largest equipment company, is planning 45 new 300-mm factories globally, says Kispert, about 10 of which are nearing completion. He doesn't know when the majority of those factories will be built, but he said his company is ready.

"We've had years where we've had to fill 30 of them," he says, adding that the growing importance of the volatile consumer-electronics market, as opposed to the more predictable and homogenous PC sector, makes it harder to estimate end demand.

Likewise, Somekh sees both positive and negative aspects to the growth of consumer electronics as part of the overall semiconductor supply chain. "The good news is this increases business as consumer products grow to consume large numbers of chips. But the bad news is that it's more cyclical and price driven."

This trend ripples through all parts of the electronics industry. "The farther up you go in any kind of supply chain, the more variability and cyclicality increase," says Somekh. "As suppliers of tools to the chipmakers, we are at the tip of a bullwhip, and we have more variation in our business."

The end result for chip-equipment companies, Somekh says, is that productivity of tools has become just as important as technology. "We need technology because the technology race has intensified, and we need productivity to allow our customers to reduce their costs and be competitive," he says.

Novellus' actions during the past year illustrate this squeeze effect of increasing tool complexity coupled with increased cost pressures. The company diversified its revenue base last year by purchasing

Peter Wolters

, a precision-machine tool manufacturer. And in March, Novellus began refurbishing and reselling used tools.

Along the same line, companies are increasingly poaching other territories to improve growth rates. At Semicon, Novellus, the seventh-largest chip-equipment company, plans on highlighting its pursuit of sales from two market segments in which it is currently a small player.

One of those areas is chemical mechanical planarization -- a field dominated by Applied Materials -- in which Novellus has been helped by using its Peter Wolters resources. The other area is physical vapor deposition, known as PVD, which also is dominated by an Applied Materials product, one that Somekh helped develop during his 23-year tenure there.

Novellus will announce that its PVD product will be used by 18 customers by year-end, up from six at the end of last year. "We feel we have turned the corner ... and it will now be a successful product for Novellus," he says.

Applied Materials, the world's largest semi-equipment company, also has been broadening its revenue base. The company made three acquisitions last year as it built its services operations and, last month, Applied targeted KLA's main money center with the introduction of a new

tool called Uvision.

As for when all these products get placed into new state-of-the-art factories, chipmakers will likely need to see tighter capacity in their current factories. So far, the follow-through hasn't been there, but consensus is building for an expected pickup in chip demand in coming months.

If that happens, equipment companies will begin to receive orders with stocks in line for some positive momentum. Until then, investors are in the same boat as executives -- waiting and wondering when the next wave of buying will happen.