Semicon Wrap Up holding pattern in turbulent air

The stock market hates uncertainty most of all. In the absence of the known, the market will assume the worst or close to it. Right now there is a lot of uncertainty that continues to have more downside beta than upside beta. Everybody we spoke to at Semicon wakes up in the morning wondering what tweet was sent at 5AM that will impact their part of the hundreds of billions of dollars of trade in the semiconductor market. Projects and plans are up in the air as no one has a clue which way things will go.

The other large uncertainty is the length and depth of the current slowdown related to the memory market and specifically Samsung. How many quarters will it last? Will it spread to other chipmakers? We also spoke to a number of people in the industry who are already thinking about belt tightening and other standard knee jerk reactions to a slowing business model.

To be very clear, business is still quite good, everyone is making money and will still be making good money just less of it in the future. Gone are the bad old days where the majority of the industry went underwater during a cyclical downturn. We also don’t expect as much of a levered negative reaction that we used to see in the bad old days when smaller companies and sub suppliers where hit harder than the larger companies. Even the smaller companies have gotten bigger and stronger and the inventory pipeline isn’t as big as it used to be. Simply put the downturn should not be as ugly nor as long lived as we have seen in the past.

The problem remains that we don’t have a hint of when the trade issue will resolve or the length and depth of the downturn and that lack of knowledge is likely more damaging than the actual reality when it happens.

TEL confirms second half slow down but hopeful for 2019 recovery
At the Tokyo Electron investor meeting as well as in private meetings, TEL, the second largest equipment maker after AMAT confirmed what we all already know about a H2 slowdown. Less clear is when it will recover. Right now the hope is in 2019 but there is no basis other than hope and assumption.

TEL is an obvious beneficiary of the current trade war between the US and China as even if the trade war is resolved, chip customers in China will be wary and probably have a built in bias away from US makers towards Japanese makers (which runs counter to their traditional distrust of the Japanese)

You can never get the toothpaste back in the tube…
Even if we manage to work things out in the trade war with China, we think permanent damage has already very clearly been done. US companies will be distrusted as their supply could be cut off in the time it takes to tweet.

China’s “Made in China 2025” got proven 100% correct as China clearly needs to be independent of US control and leverage. Non US semiconductor companies will benefit and China will be looking for a work around for everything they depend on. This probably also doubles the pressure on Chinese hackers to steal more IP as they are more afraid of not being able to get it legally.

Waiting on Lam…the elephant in the room that isn’t talking
Its pretty clear that Lam will likely see most of the impact of Samsung’s memory slowdown. Their absence at Semicon and lack of pre-announcement only fans investor concerns and industry speculation.

Our view is that the downside risk to the stock remains as analysts can’t really do a good job of cutting estimates with nothing to go on and will have to wait until Lam announces to adjust their estimates and targets and it will take a while for the market to absorb the changes. Others in the industry will likely breath a sigh of relief once Lam officially announces reduced numbers as it reduces the speculation on their own performance.

Avoiding the “death by a thousand cuts”
Our main hope is that Lam and other companies in the industry cut their expectations enough in this first round so that we don’t get stuck in the downward death spiral of reducing numbers every quarter until we hit bottom. Expectations need to be reset to a level where the industry can meet and exceed them without worrying. Although its hard to adjust numbers to account for trade issues and we would not expect that, we think that the industry can take a whack at re-adjusting spending in light of memory pricing and near term demand. Better to under promise and over deliver in the stock market game.

Embrace the “Cycle” ….it takes pressure off management
We think that managements who have pushed the idea that this is no longer a cyclical industry have done themselves and the industry a disservice. They can no longer shift the blame and point their finger at the cyclical nature of the industry as the culprit . Since the business is up and to the right forever it must be managements fault for any blip or bad performance for several quarters cause its no longer a cyclical industry. Embrace the cycle…its your friend and whipping boy.