MEMC Electronic Materials (WFR)

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Avinash Gandhi

Thomas Shyr

MEMC Electronic Materials (NYSE:WFR) supplies silicon wafers to semiconductor and photovoltaic cell companies. Its success is deeply rooted in the success and growth of the market for semiconductors, which is in turn fueled by a growing demand for mobile phones and solar power. Solar power in particular has been growing quickly as oil prices, environmental concerns, and government support for clean and renewable energy have all increased.

Silicon wafers are commodity goods, meaning they are difficult to differentiate in any way other than price. Thus, while a worldwide silicon shortage is currently lifting the fortunes for all players in the industry, in the long run, price competition with competitors like Hemlock, Shin-Etsu, M. Setek, and DC Chemical can undercut MEMC's profit margins. To try and reduce this threat, MEMC has hedged some of its positions against falling semiconductor prices, including a multimillion dollar agreement to supply China's Suntech Power Holdings (STP), a solar power company, with silicon wafers over the next 10 years.

Company Overview

MEMC Electronics is a silicon wafer manufacturer whose majority shareholder, Texas Pacific Group--a prominent private equity firm--acquired a 72% stake in 2001, after the company nearly filed bankruptcy. Since then, MEMC has made a remarkable recovery and now generates a free cash flow and has far higher profit margins. TPG, however, has been selling off chunks of the company during industry upturns ever since 2001 (right now, it owns 7.3%, but is still considered a major shareholder). This is significant because when TPG sells at a stock peak, MEMC's shares plummet, making the company extremely vulnerable to TPG's actions.

Business Financials

In 2009, WFR earned a total of $1.16 billion in total revenues. This was a significant decline from its 2008 total revenues of $2 billion. As a result, this had a severe negative impact on WFR's net income. Between 2008 and 2009, WFR's net income declined from a net profit of $387 million in 2008 to a net loss of -$70 million in 2009.^[1]

Product Breakdown

As a silicon wafer producer, MEMC Electronics' products are used in semiconductor technology and in photovoltaic cells; semiconductors are used in computer technologies, like memory chips and integrated circuits, and photovoltaic cells are used to produce electricity from light energy. MEMC produces five main categories of silicon wafer.

• Polished Wafers: Polished wafers are high quality silicon wafers that have been chemically and mechanically polished to reduce imperfections, like pits in the wafer, and improve the semiconductor properties of the silicon.
• Epitaxial Wafers: Epitaxial wafers are special silicon crystal wafers that are grown on top of standard crystal wafers; their properties allow them to increase reliability and also allow them to isolate different circuit elements in smaller devices, smoothing chip communications.
• Perfect Silicon: MEMC's "Perfect Silicon" wafers are defect-free, making them useful for highly advanced semiconductors and also freeing them from the need for the post-production engineering necessary to reduce flaws in other wafer types.
• Magic Denuded Zone Wafers: Oxygen combines with silicon very easily to produce imperfections in the wafers; most wafers need timely post-production engineering to control oxygen precipitation. MDZ wafers use patented MEMC techniques to control and reduce oxygen precipitation in the silicon without the need of such processes, keeping the silicon useful over time.
• Advanced Materials: MEMC's advanced wafer materials have higher electrical resistivities (resistance to the flow of electricity), making them ideal for wireless communications chips.

While these wafers appear to be significantly differentiated, the reality is that the silicon wafer industry is essentially a commodities industry: products cannot be differentiated enough for different companies' products to be competitive by feature. As long as a wafer is pure enough to work without causing signal malfuntion, customers will purchase based on price, making the industry subject to low profit margins.

Trends and Forces

Though there is very little that the company can do to differentiate itself competitively from competing silicon dealers other than lower prices, MEMC's overall success depends on the success of products that use silicon wafers, specifically semiconductors and photovoltaic cells. MEMC's products are sold en masse to a relatively small number of firms. This allows MEMC to take advantage of economies of scale but leaves the company at risk in the event a large customer leaves. For example, competitor Siltronic recently signed a deal to provide silicon to Samsung, one of MEMC's key customers. Samsung cutting MEMC ties would be disastrous for MEMC's revenues. Thus, demand by firms in the semiconductor and solar industries affects MEMC powerfully.

Demand for Semiconductor Technology

Semiconductors are found in all microchips and anything that receives radio waves; this ranges from car radios to WiFi cards. The IT economy has been called the "silicon economy" because silicon is the primary material used to create semiconductors. The silicon wafer industry is relatively oligopolistic and about 10 firms supply silicon wafers worldwide. MEMC is in the top three and there is no clear industry leader.

The Digital Native

The digital native demographic is defined as the younger generation, which has grown up with constantly evolving technologies. Increased usage of digital photo, video, and sound drives the demand for newer, faster, more powerful hardware. Faster microchips will be necessary to meet this demand, which necessitates improving semiconductor technology. An increased demand for high-end silicon wafers would play to MEMC's established business strengths.

Mobile Platform Growth

With the increase of mobile platform functionality, consumers are demanding faster, more powerful mobile devices to drive applications on smaller devices (e.g., wireless Internet). High-end semiconductors are crucial to radio devices such as cell phones as well as to microchip production and could be in far higher demand as the mobile market expands for two reasons. Semiconductors drive both data quality transmission as well as advanced hardware on high-end phones.

Demand for Solar Power

Solar power is a rapidly emerging form of energy production that converts light (usually from the sun) into electricity through the use of photovoltaic cells, which are typically made of silicon wafers. Solar energy continues to grow as a viable form of electricity because of rising oil and gas prices, increased public awareness of environmental issues, and rising political support for clean energy. With oil hitting $100 per barrel in late 2007, the demand for alternative energies, such as solar, became more noticable. MEMC signed two notable solar contracts with Asian solar cell manufactures, Gintech and Suntech Power Holdings (STP). MEMC will provide solar wafers to the two companies. The contracts amount to between $7.5 - $9 billion dollars over the next 10 years. With these new contracts MEMC says it has solar agreements worth between $15-$18 billion over the next 10 years.

Silicon Prices

The rising demand of solar power has led to a shortage of silicon production and higher prices. In a price-competitive commodity industry, companies such as MEMC see positive revenue effects. However, the industry is highly cyclical and prices tend to fluctuate due to over- or under-supply of silicon as well as changing market conditions. In the long run, rising demand for silicon wafers due to solar power may generate a long-term upward shift for the semiconductor industry.

Competition

It has been established that there is very little that can be done to differentiate silicon wafers; thus, MEMC competes with other firms through pricing. There are fewer than 10 major competitors in the industry, including companies such as Hemlock, Shin-Etsu Chemical, M. Setek, and DC Chemical. The activities of these companies play a major role in reducing MEMC's profit margins through output expansion and price reduction.

References

1. ↑ WFR 10-K 2009 Item 6 Pg. 27