Tech Hardware Supply Chain - Gazhoo

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Bhavin Shah (852) 2800-8538 bhavin.a.shah@jpmorgan.com The gap between fabless and foundry revenue Q/Q growth tends to converge to zero Our analysis suggests that either foundry orders will drop in 3Q09, or the fabless revenue will have to be revised upward 332 Asia Pacific Equity Research 20 April 2009 The gap between fabless and foundry revenue Q/Q growth converges to zero over time Over time, we expect the gap between fabless and foundry revenue Q/Q growth to converge to near zero as: a) fabless houses are major clients of foundries, contributing around 70% of the total foundry revenue; and b) the gap created in each quarter due to inventory buildup/burn-down should be offset over time because of the consistency. Having reached near zero back in 3Q05, based on current 2Q09E estimate of around 100% Q/Q revenue growth for foundry and 8% Q/Q for fabless, the cumulative difference of the gap should do a complete flip-flop—from a record high of +50% in 1Q09 to -45% (i.e., higher foundry growth versus fabless growth) in 2Q09. Hence, the market must adjust itself to narrow the gap and imply one key message: Either foundry orders will drop in 3Q09, or the fabless revenue will have to be revised upward, in our analysis. We do believe that through the earnings season, fabless revenue growth estimates will be revised upwards, but the gap should remain fairly large—at least -15% to -20%. Although we assume fabless revenues would grow 9% in 3Q09 and 8% in 4Q09 and that foundry revenues will decline 11% in 3Q09 and 3% in 4Q09, the gap should not get back to zero by end-2009, in our view. Table 175: Cumulative gap of fabless vs. foundry revenue Q/Q since the last near-zero quarter 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09E 2Q09E 3Q09E 4Q09E Cumulative gap 1% -4% 4% 2% 6% 14% 24% 21% 12% 11% 12% 8% 17% 24% 50% -45% -24% -14% Source: Companies, Bloomberg, and J.P. Morgan estimates. A similar case could also be observed in historical data: In 2Q02, foundry revenue grew 34% Q/Q, whereas fabless revenue declined 2% Q/Q. In the following two quarters, foundry revenues saw a 4% Q/Q decline despite 8% and 9% Q/Q increases in fabless revenue. As another example, in 3Q04, fabless inventory days peaked with the cumulative gap reaching a record low of -12%. It ended up that foundry revenue then met with sequential drops of 8% and 14% in the next two quarters (Figure 211). Given continued lack of confidence on global end-demand improvement, we believe a correction in foundry is a more likely scenario. We expect most of the market adjustments to happen in 3Q09. Figure 211: The cumulative gap between fabless and foundry revenue, Q/Q - 40 30 20 10 (10) (20) Day 1Q98 2Q98 3Q98 4Q98 1Q99 2Q99 3Q99 4Q99 1Q00 2Q00 3Q00 4Q00 1Q01 2Q01 3Q01 4Q01 1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 Fabless DOI - abov e/below av erage of 65 day s Foundry rev QoQ (RHS) Fabless rev QoQ (RHS) Cumulativ e gap (RHS) Source: Bloomberg, companies, J.P. Morgan estimates. 150% 100% 50% 0% -50% -100%
Bhavin Shah (852) 2800-8538 bhavin.a.shah@jpmorgan.com Fabless inventory days might reach another peak in 2Q09 Foundry orders could be cut again in 3Q09, if end-demand remains weak Asia Pacific Equity Research 20 April 2009 Figure 212: Fabless inventory days (by current COGS) US$m Day s 5,000 4,500 Fabless companies' Inv entory Lev el (US$M, Left) Fabless companies' COGS (US$M, Left) Inv entory Day s (Day s, Right) 100 4,000 3,500 90 3,000 2,500 80 2,000 1,500 70 1,000 500 60 0 50 1Q00 2Q00 3Q00 4Q00 1Q01 2Q01 3Q01 4Q01 1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 Source: Bloomberg, Company data, J.P. Morgan. Note: Companies include: QCOM, NVDA, BRCM, MRVL, LSI, Mediatek, XLNX, ALTR, Novatek, RFMD, HIMX, CSR, OVTI, CNXT, ZRAN, Realtek, PMCS, VIA, ATHR, SSTI, SLAB, SIRF, SMTC, Sunplus, TRID, DSPG, AMCC, LSCC, Richtek, CRUS, ADPT, and Orisetech. Fabless inventory days might reach another peak in 2Q09 Exiting a high DOI of 75 in 4Q08, we believe foundry suffered from an unprecedented drop in 1Q09 and inventory days thus would have come to a very low level. However, the jump in 2Q09E foundry orders together with relatively flat fabless growth might bring the DOI to another peak level, in our view. If end-demand doesn’t pick up, foundry orders could be cut again in 3Q09 To digest the piled-up inventory, fabless companies must adjust their orders booked to foundries. If they don’t see an end-demand pickup, the only answer for these foundry customers would be to cut orders, in our view. This supports our previous argument of either a correction in foundry or an upward revision in fabless. Note that exiting 4Q00, fabless inventory days piled up to 81 days and continued to be built up to 101 days in 1Q01, resulting in a significant foundry volume correction in the subsequent three quarters by 61% in total, which is at a similar level to our forecast of a 60% drop (3Q08-1Q09E) in the current downturn. However, endmarkets were down only low-single digits in 2001 and we now assume that endmarkets would be down 15% in 2009. This implies end-markets will have to have a very strong recovery in 2H09. Table 176: Fabless inventory assessment model US$MM 1Q08 2Q08 3Q08 4Q08 1Q09E 2Q09E 3Q09E Fabless-related foundry sales: 2,851 3,027 3,033 2,133 1,248 2,530 2,253 QoQ -2% 6% 0% -30% -41% 103% -11% Fabless sales 9,368 9,654 10,597 7,906 6,810 7,354 8,052 QoQ Annual forecasting basis -4% 3% 10% -25% -14% 8% 9% Implied inventory build-up / burndown % -4% 6% 7% 3% -7% -8% -8% Fabless Inventory days (by Current COGS) Quarterly forecasting basis 68 69 64 75 70 64 59 Implied inventory build-up / burndown % 1% 3% -10% -4% -28% 95% -20% Fabless Inventory days (by Current COGS) 68 69 64 75 54 106 84 Source: Bloomberg, Company data, J.P. Morgan estimates. 333
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