Published note:
TSMC cuts Capex by $1.5B- No surprise, as biz slows - China trade can kicked far down the road, out of sight - Litho (ASML) will gain as we pass multipatterning peak...
We have more crosscurrents in the semi industry as we have gotten the first couple of companies to report.
TSMC is slowing its Capex spend to reflect a slowing business environment. This $1.5B cut was more or less expected as the company had previously talked about slowing crypto demand and slowing smartphone. The capex cut was in line with what was expected and some of the cut is just a push out but does none the less impact near term spend.
We think the China trade issue has been kicked so far down the road, as to no longer be visible and as to not impact results or stock prices for at least another quarter. Not only has the China trade issue been pushed out of sight but a new larger crisis of Russia has emerged to take its place and we doubt the administration will resurface the China issue anytime soon.
To be very clear, the China issue is far from dead and we will see it return at some point and likely do some damage to both imports and exports, but we think that perhaps for the remainder of the year the issue is on the back burner and will not likely impact stocks. We would still keep a sharp eye on that back burner pot because as we have come to understand with the current administration that things can explode at a moments tweet.
ASML's report yesterday coupled with TSMC's comments reminds us that we are likely seeing a peak of multipatterning in the chip making business and will likely see the fortunes of percentages of capex WFE spend shift back towards litho and away from dep and etch. Litho has lost share over the past years as EUV was very late and multipatterning was the work around to keep Moore's law on track. While EUV is far from perfect we do expect manufacturers to increase its use and work out the kinks as it is needed for the industry to make continued progress.
It is well known that an EUV process flow replaces many more steps in a multipatterning flow and that is the basis for the eventual cost savings that EUV brings (even if that savings is minimal or does not exist today...) EUV also brings about performance enhancements that end customers want and perhaps want sooner rather than later as is the case with Apple.
As such we think we are at the peak of the multipatterning trend and will see spend move away from dep and etch towards litho as the process flow changes over the next few years. We think TSMC will lead that change as Samsung will still spend a lot on dep and etch for 3D memory stacks unrelated to multipatterning. Samsungs logic will also shift spend from dep and etch to litho as will Intel.
TSMC put its $1.5B in cuts into three buckets; $600M in plain old fashioned cuts, $700M in push outs (probably into next year but could be considered cancelations) and $200M in Forex gains.
Spending has been coming down sharply at TSMC much in line with expected business slowing from $2.5B in Q1 to $2B in Q2 and versus $3.5B a year ago.
We are now in a likely $2.5B per quarter spend rate with maybe $2B in "base" ongoing spend and $500M related to special spending such as last quarters spend on litho and mask capacity.
TSMC made comments about simpler processes which is clear code for going to EUV away from multipatterning (which simplifies the process..) which causes us to remind investors about this impending shift in the foundation of the industry.
China trade issue out of sight....for the time being
The administration kicked the export control and foreign investment can down the road to congress. As we previously discussed, congress can't do anything in a reasonable period and as expected things have slowed considerably.
We have spoken to a number of people familiar with the situation in Washington and have come away with some conclusions. FIRRMA (Foreign Investment Risk Review Modernization act of 2017) is CFIUS on steroids as it not only enhances CFIUS controls and goes into more detail but also adds export controls to the new proposed "super CFIUS". FIRMMA has been proposed in both the house and senate and is now in committee to work out a common version. This common version that could be voted on and sent to the President will not likely see sunlight until some time in the fall.
Even if this gets voted on and passed by the senate, house & president by November it still needs to get implemented. There is likely a very long list of items in the queue that FIRRMA (Ex CFIUS) will have to deal with. This very long "backlog" of issues will likely push far into 2019, with M&A transactions getting priority and export controls getting lower priority.
However, we would be concerned that when FIRRMA does get around to export controls we will likely see a return to export licenses as we had in the past when leading edge technology sales to China were restricted. FIRRMA talks a lot about emerging technology which is likely code for AI, machine learning and AR/VR but semiconductor technology like EUV is buried in there somewhere.
Link to proposed FIRRMA bill in Congress
In summary, we think that the risk of export controls on semiconductor equipment have likely been pushed into 2019 and out of the investment horizon that impacts the stocks. Of course the administration could always move trade back to the front burner to distract people away from the Russia debacle and try to win points in front of mid term elections but so far that tweet hasn't happened...stay tuned.....
The litho pendulum swings back
We were one of the first in the industry to point out the upside of multipatterning as EUV was delayed. We may be a little early on EUVs impact on slowing multipatterning but we think investors need to add it to the overall equation of the equipment industry dynamics which includes slowing memory, China risk, Moore's Law etc. Without doubt we will see litho (ASML) capture a much larger percentage of overall spend of WFE Capex over time. While this does not impact all of the upside we have seen in dep and etch over the past years (it does not impact increased dep/etch for 3D NAND), we will see the uptick in dep/etch slow and go back to a more normal percentage.
TSMC's spending on litho related expenses in Q1, their talk about a "simpler process" in Q2 coupled with ASML's continued march forward on EUV reported yesterday all point to the shift happening in real time.
TSMC used to be the leading anti-EUV chip maker or an at least an EUV doubter. Now TSMC has completed its 180 degree turn and is clearly in love with EUV and claims to be the leader with the most tools (as discussed on todays call). The reversal is quite sharp and surprising in its speed. We would not underestimate the speed at which EUV could be implemented once we get past some critical inflection points. While the DUV conversion certainly did not have the myriad of issues that EUV has, the conversion was fairly quick.
Modulating Spending at Samsung and TSMC
It should be no surprise that like any other industries, when things slow down you slow down your spending. Both Samsung and TSMC have clearly slowed their spending as their end businesses slowed.. While fab construction is a multi year project, the companies have been controlling their spending on a much shorter term basis by accelerating or decelerating spending inside of a quarter, to manage their profitability.
While companies still have to do "base" R&D spend to keep pushing Moore's law forward, there is a lot of variable spend that has variable timing and amplitude that greatly impacts the quarterly fortunes of the industry. This "cyclical" spend will still drive the stocks even though the long term prospects remain very positive.
Investors can't ignore these cyclical, short term patterns given the volatility of the stocks that can see their values move sharply in a short period. Buy and hold may work in other industries and may work in the very long term in chips but a lot more money can be made by playing these near term trends. This near term spending modulation isn't going away any time soon.
Cyclical -
"of or denoting a business or stock whose income, value, or earnings fluctuate widely according to variations in the economy or the cycle of the seasons" (definition from Dictionary.com)
TSMC and "advanced packaging" - More than Moore
The TSMC call also reminded us of advanced packaging as a way of pushing Moore's law without the traditional geometric silicon shrinks. We think that many in the industry have ignored this growing segment of the industry that will continue to see increased growth, focus and spend. We think TSMC will continue as one of the leaders with its "fan out" and other similar technologies.
The stocks
Even though it was expected, the news of TSMC capex cuts also cut the equipment stocks. Some of this was likely related to the stocks being up yesterday more than they should have on ASML's report.
TSMC cuts do however add to the memory slowdown and we will see that impact when Lam reports. We see no really good reason to take the risk and own Lam or AMAT going in to Lam's report. KLAC has less exposure and risk but is sympathetic. While the China risk has been pushed out, memory risk is more real. Its very clear that TSMC, Intel and others will not offset Samsungs slow down so we don't see the upside in the near term as H2 will clearly be down.
