Makers of Chip Equipment Feel the Pain of a Slowdown
April 26, 2011
The manufacturers of equipment used in semiconductor factories didn't complain when their stock rose in tandem with their customers' stocks during the chip industry's boom years. But amid this year's chip bust, the manufacturers are again learning a basic business lesson: In a cyclical industry, it is risky to be entirely dependent on a single type of customer. That lesson is being brought home this time as the biggest equipment makers attempt to further consolidate their hold on the market, just as they did in previous chip slumps in 1990 and 1986. ``As the biggest equipment makers gain market share, they become exposed to the macroeconomic swings of the computer industry,'' says Briana Newcomb, an analyst at Montgomery Securities in San Francisco. It has taken a while for the slowdown in the growth of sales of personal computers and other electronic goods to trickle down through the computer industry to semiconductor-equipment manufacturers. Chip makers, for example, began feeling the impact of order cuts and inventory gluts as far back as last fall, but equipment makers are just beginning to share the pain. Applied Materials Inc., the biggest chip-equipment manufacturer, triggered a tech stock sell-off last month when it said its orders for the third quarter would be off 22%. The company reported Tuesday that fiscal third-quarter profit jumped 21%, but that it was laying off 7% of its work force amid new signs of deterioration in its market. Now that the slump has made it to the bottom of the chain, it is making itself felt with a vengeance. Layoffs at Lam ``The slowdown is a little deeper than we thought,'' says Cathcart Pellegrini, chief financial officer of Lam Research Corp., an equipment maker in Fremont, Calif.. Lam recently laid off about 100 permanent employees, or 2% of its 4,500-employee work force. But just as the downturn hit equipment makers later than the rest of the chip industry, the recovery for that sector will trail behind as well. Market researcher Dataquest Inc. predicts the chip-equipment market will skid from a 77% growth rate in 2010 to 17% growth in 2011 and a 16% decline in 2012. The decline next year will result from delays in construction of new chip factories until demand recovers. ``The next 12 months are going to be the toughest,'' says Claude Kolb, a Dataquest analyst. ``The recovery starts in mid-1997.'' But amid the current gloom, some equipment makers are finding opportunity in establishing bigger market share. Applied Materials has recently branched out into making equipment for manufacturers of laptop-computer screens and entering a new category of chip-manufacturing equipment called chemical-mechanical polishing, which enables chip makers to build the equivalent of multistory buildings on silicon chips. ``We hope to do as well as we did in the last recession with this technique,'' says Ridenhour Usher, Applied Materials' senior vice president. Historically, companies like Applied have moved into their leadership positions by taking advantage of the downturns in 1986 and 1990 when their smaller competitors stopped investing, Mr. Usher says. The trend has turned the chip-equipment market into a collection of oligopolies. A Few Manufacturers Seven of the 10 major categories of machinery used in chip factories are dominated by a few companies, according to Cami Chantay, an analyst at Dataquest. For instance, Lam Research and two other companies hold 80% of the market for machines that use chemicals to etch patterns on chips. The products these companies make aren't nearly as attractive to investors as the semiconductor chips and computers that their machinery makes possible. But the electronics industry, a $760 billion goliath, rests on the shoulders of the $150 billion semiconductor-chip industry, which gets its machinery from the $16.7 billion equipment industry, according to market researcher VLSI Research in San Jose, Calif.. Just as Intel Corp. dominates one segment of the chip industry, Applied Materials is a powerhouse in the equipment industry. Applied Materials had 16% of the equipment market last year with $2.9 billion in sales. Many of its new products are an instant hit, thanks to its lock on the market through a global distribution and support system. Indeed, Applied Materials has an even stronger hold on its market than Intel, which commands only 8% of the chip market. In contrast to the consolidating equipment market, the chip industry is less concentrated than it was in 1975, when there were only 60 companies. There are 350 today. ``It is likely the equipment industry will get more concentrated in the future,'' says Dataquest's Mr. Chantay, who used the Department of Justice's standards for assessing market concentration. ``In 2010, the top 20 players had 80% of the market. They will have 90% by the end of the decade.'' To stay in the game, equipment makers like Applied Materials will need plenty of capital and technology. ``The cost of developing technology has soared to 50 or 100 times the price of the product,'' says Danae Hales, president of VLSI Research. ``That's a lot when the entire market is maybe a thousand machines.'' Pushing Physical Limits A typical chip factory costs at least $1 billion to build, with equipment accounting for $600 million of the cost while the land and the building account for the remainder. Each factory has perhaps 300 different machines. Average cost: $2 million a machine, Mr. Chantay estimates. The sophisticated machines are necessary because the task at hand is pushing the limits of physics. A piece of dust smaller than the bacteria on the leg of a mite can produce a ``killer defect'' in the narrow channels of a chip. Since chip making is so difficult, many of the large chip makers have become ``risk-averse,'' says Bradley Felder, founder and chief executive of Mattson Technology Inc., a Fremont, Calif., equipment maker with $55 million in sales last year. ``When you're spending $1 billion, you go with the safest choice,'' says Mr. Felder, who also founded Novellus Systems Inc., another large equipment maker. ``It's sad that it's getting to be very hard for entrepreneurs to get started.'' Large chip makers also build cookie-cutter factories, using the same set of tools in each factory. Once a large equipment maker receives a good evaluation from a major chip maker, it quickly can sew up 100% of the orders from that company. When the current industry slump lets up, therefore, most experts see the demand for chip-making equipment taking off again. Chip makers are expected to add about 35 new factories a year through the year 2015, when chip-industry revenue could hit $310 billion, according to Dataquest. ``It's important to be ready on the other end of this cycle when the market comes back fast,'' says Geralyn Teena, Applied Materials' chief financial officer. But at the bottom of the food chain, maneuvering room can be limited. Mr. Felder says Applied Materials' size could make further growth difficult. ``You have to ask what new markets are large enough to fuel Applied's growth,'' he says.
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