investment viewpoints
Semiconductors: the new oil
Semiconductors are at the heart of all modern electronics systems, making them essential to the digital age. The pandemic has spurred demand for these vital components but structural and cyclical forces are set to take it higher.
Semiconductor manufacturers are experiencing heightened demand for chips, which is exposing bottlenecks in the supply chain, as well as opportunities for expansive development. Intel1 recently committed USD 20bn to constructing two new semiconductor factories in Arizona, in a bid to revitalise manufacturing within the west. Competition in this space is likely to intensify further as demand continues to rise, both in the short and long term.
The COVID-19 pandemic has had an effect on demand for semiconductors. The events of last year drove many businesses to take drastic measures in order to be able to continue operations and reach their end customers. Businesses had to accelerate the pace of digitalisation by adopting cloud-based services at a faster pace. This has led to increasing demand for cloud computing, which translates into demand for semiconductors.
The events of last year drove many businesses to take drastic measures in order to be able to continue operations and reach their end customers
Individuals also had to adapt to working from home and this deeply impacted how people run their lives and their consumer choices. This situation stoked demand for upgrades in electronics such as laptops or computer monitors. The lockdowns and social distancing requirements also shifted recreational activities towards the digital, leading to a surge in demand for similar products, as well as consoles, televisions, and other devices. The traditional PC market recorded 11.2% growth, year over year, in the second quarter of 2020. Consumer spending on video gaming hardware rose 35% to reach $5.3 billion, from 2019.
In 2021, as the economy start reopening, we believe that three additional trends are set to take demand for semiconductors to even greater heights.
Electric vehicles
One of the driving factors behind the worldwide demand for semiconductors is the rapid growth of the electric vehicle market. Semiconductors power a range of important features, from advanced driver-assistance systems (ADAS) to batteries, and are present in greater quantities in EVs than regular combustion vehicles.
Sales of electric cars came in at 2.1 million globally in 2019, surpassing an already record year in 2018. Electric cars registered a 40% year-on-year increase, taking the available stock to 7.2 million. There is little to indicate this upwards trajectory is at risk of trailing off. A mix of technological advancements, infrastructure investments, and policy pledges are raising the number of electric vehicles on the roads, and this has much further to run.
It is estimated that sales could reach 11.2 million by 2025, followed by 31.1 million by 2030. We think third party forecasters are actually underestimating penetration rates. In key European markets, such as Germany and the UK, demand was up triple digits, even at the peak of lockdowns in March 2020, whilst internal combustion engine (ICE) sales collapsed by 50%. It is important to note that electric vehicles also typically contain a greater quantity of semiconductor technology. Semiconductor manufacturer Infineon1 estimates that there is on average nearly double the amount of semiconductor content per EV as there is for the average combustion vehicle.
There are several factors which stand to drive sales of electric vehicles going forwards and, by extension, increase demand for semiconductors. The first comes in the form of government initiatives designed to accommodate and promote the use of electric vehicles. The second is the declining cost of batteries.
The European Union has pledged to have at least 30 million zero-emission vehicles on its roads by 2030 and will stressed the importance of investing in smart charging infrastructure requirements, such as public charging points, in order to achieve this. The European Commission’s mobility strategy notes that manufacturers are already heavily investing in battery-electric vehicles and take-up is growing for cars, vans and buses used in cities. In the US, President Biden’s administration has similarly unveiled plans to build more than 500,000 charging stations, and to replace the government’s fleet of roughly 650,000 vehicles with electric models.
The growing popularity of electric vehicles can also be attributed to the significant improvements in technology that have been made in recent years. The International Energy Association (IEA) notes that the electric vehicles of today display a battery energy density that is between 20% and 100% higher than was achievable in 2012, and that battery costs have decreased by more than 85% since 2010. It is our view that, once battery costs reach a “tipping point” of $100/KWh, car manufacturers can make battery electric cars (BEV) as profitably as ICEs. At this point, current EV forecasts will prove too pessimistic. It took just two decades for the car to take 95% share from the horse; we expect a similar speed of revolution to electric mobility, which will significantly increase demand for semiconductors.
5G smartphone cycle
5G, or fifth-generation wireless connectivity, offers a lot of consumer-friendly advancements on 4G, including improved bandwidth, latency, reliability, connection density and security. Semiconductors are critical for the deployment for 5G, as they are central to signal transmissions, network connectivity, and data management.
5G is also empowering a new generation of faster and better smartphones. Consumers can expect better download and streaming speeds and the improvements in reliability makes it so that smartphones can connect to the cloud more reliably than before. This means applications will no longer be limited by a mobile handset’s hardware.
Demand for 5G smartphones is set to rise this year and beyond due to a variety of factors, including the growing availability of 5G networks coupled with a higher variety of lower end 5G smartphones. Gartner forecasts sales of 5G smartphones will total 539 million units worldwide in 2021 – more than double the sales figures for 2020 - which would represent 35% of total smartphone sales. The sale of 5G units is expected to overtake the sale of 4G/3G handsets by 2023.
Sales are likely to be driven by the fact that consumers who want the full 5G experience will most likely have to buy a new handset and upgrade from their existing 3G or 4G phone. This is where we see this much faster rebound in cyclical industries driving demand. Consumers were found to have reduced spending on smartphones in 2020 which has led to a lot of pent-up demand. We believe consumers will start to resume standard commercial activities as life starts to return to normal, post pandemic. This, together with the arrival of new lower-end phones and the resumed rollout of 5G, leads us to believe that there will be a significant uptick in demand starting this year.
This has significant implications for semiconductor manufacturers. The world’s largest semiconductor manufacturer Taiwan Semiconductor Manufacturing Co. (TSMC)1 derived approximately half of net revenue from smartphones in 2020 and recently raised its revenue forecast for the full year, to reflect strong demand for 5G smartphone launches like Apple’s new iPhones.
Internet of things (IoT)
The impact of 5G goes far beyond smartphones. 5G is the cornerstone of a full connectivity revolution that stands to substantially advance the digitalisation of our society and economy.
The role of 5G in the wider context will be to help address gaps in broadband availability and enable unprecedented levels of connectivity. This has enormous implications for the development of the Internet of Things (IoT), which is poised to substantially disrupt the semiconductor industry.
5G is the cornerstone of a full connectivity revolution that stands to substantially advance the digitalisation of our society and economy
The IoT is the term used to describe a network of devices that collect and share data. Consumers will no doubt be familiar with the first wave of IoT devices and the new functionalities they offered, including smart doorbells that stream video footage of visitors; and wearable devices that collect, send data and receive information used to monitor health.
The Internet of Things is projected to rapidly expand in the coming years – boosted by advancements in connectivity and technology - and stands to bring about transformational change to many sectors including manufacturing, healthcare, and transportation. It is estimated that there will be as many as 64 billion IoT devices by 2025, which will account for 55% of all data generated.
This expansion also reflects a significantly wider client base for semiconductor manufacturers. In addition to computing equipment and handsets, the connected universe that is dependent on semiconductor technology is widening to include home appliances, manufacturing equipment, and agricultural tools, as well as an ever-growing wealth of consumer and commercial devices.
The Internet of Things has the potential to serve as an important source of revenue for semiconductor companies as it grows and matures. The next generation of IoT devices will depend on new semiconductor technology to support better power efficiency and performance. Improvements in 5G availability will offer more opportunities for companies to integrate their products with the IoT through the use of semiconductor technology.
Conclusion
The future of a vast array of sectors, including mobility, communication and manufacturing, all depend on the global availability of semiconductors.
Today, the supply chain is highly consolidated and relies on a handful of player in certain steps of the manufacturing process. Currently, we are experiencing a combination of accelerating structural forces (EV, IoT, cloud) and a faster-than-expected rebound in cyclicals (smartphone, cars) which is provoking some bottlenecks due to high consolidation.
The shortage has already had the effect of severely hampering auto production, and has prompted the White House to start drawing up potential long-term solutions. President Biden recently signed an executive order that launched a comprehensive review of US supply chains, and noted that the country has underinvested in the production of these vital components. The US share of global semiconductor manufacturing has been in steady decline for decades; down from 37% in 1990 to 12% today.
The future of a vast array of sectors, including mobility, communication and manufacturing, all depend on the global availability of semiconductors
This highlights a second characteristic of the semiconductors supply chain, which is that it’s one of the most globalised ones. Today, we see countries such as the US and China increasingly concerned about securing their own manufacturing capabilities in order to meet demand and reduce external reliance for this highly strategical industry.
From an investment perspective, equipment manufacturers stand to be net beneficiaries of these trends. In addition to meeting the growing demand, manufacturers are also benefitting from the new growth avenues structural forces are opening up. TSMC1 notes that the new class of IoT devices that 5G and AI will enable, for example, require new semiconductor technology to support the need for faster performance, improved power efficiency and improved power leakage.
The semiconductor manufacturing equipment market is projected to reach USD 103.5 billion by 2025 - up from USD 66.1bn in 2020 based on the vital role they play in the ongoing digitalisation of society.
1 Any reference to a specific company or security does not constitute a recommendation to buy, sell, hold or directly invest in the company or securities. It should not be assumed that the recommendations made in the future will be profitable or will equal the performance of the securities discussed in this document
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