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Semiconductor Manufacturing International (SMI)Stock (Semiconductor - Foundry Industry, Semiconductor - Integrated Circuits Industry)
 As the only pure-play mainland Chinese semiconductor foundry, the company is tapping into domestic demand growth with the Rise of China's Middle Class, seeing a 56% growth in domestic orders in 2007.[2] However, the company is still struggling with operating profitability, and had not turned a positive operating margin between FY 2005 - FY 2007.[3] Despite dropping the low-margin memory business in Q1 of 2008, the company earned a gross margin of -9.0% that same quarter.[4] These are operating hurdles prevent the company from being considered in the same tier as competitors Taiwan Semiconductor Manufacturing Company (TSM) and United Microelectronics (UMC), the market's #1 and #2 by revenues. [edit] Business DescriptionSMI is a manufacturer, and operates its factories throughout mainland China. The company has taken advantage of local tax incentives spurred by Chinese municipalities to gain tax incentives and foster relationships throughout the country. The cash subsidies totaled $27MM in 2007.[5] The company's client concentration is high, with 18%, 16%, and 8% of 2007 revenues coming from the companys largest 3 customers.[6] The company does not name who these customers are. Strategic alliances with Chartered Semiconductor Manufacturing (CHRT), Toshiba (TOSBF), Infineon Technologies AG (IFX), Fujitsu Limited (FJTSY), Motorola (MOT), ARM, Elpida Memory, Inc. and IMEC have provided access to intellectual property (IP) associated with a variety of semiconductor process technologies. Other services include libraries and circuit design blocks, in-house photomask capability, wafer probing, assembly/test and design support. [edit] Financial Analysis SMI Revenue and Margins 2005-2007[7]
SMI's gross margin is in the single-digits, and its operating margin has been negative for the years 2005-2007. This suggests its underlying operations are not profitable. This is caused by the prevalence of the company's DRAM sales, which are low margin. As of Q1 FY 2008, the company is preparing to exit this lower margin business[9] and had already been shifting its customers to different chips.[10] Regardless, its operating profit is still a long way from technological leader Taiwan Semiconductor Manufacturing Company (TSM),[11] showing that it lacks the operating efficiencies of scale that TSM has.  SMI Geographic Revenue 2005-2007[12]
The companies revenues are nearly evenly divided between the 3 major markets of North America, Europe, and Asia. However, the most interesting growth engine for SMI comes from its deals within China. While it does not give an breakout, the company declared that it experienced a 56% growth in China-originated orders in 2007.[14] [edit] Trends/Forces[edit] SMI is a low/negative margin business, compared with competitor TSM, making its business vulnerable to volatilityAs the withdrawal from the DRAM business demonstrated, changes in SMI's business can cause negative financial results, due to distances to the utilization of the factories. This is because SMI needs to run its factories at full-steam to make itself profitable, due to the high level of fixed costs involved in its business. Decreases in business caused by issues with suppliers, fewer orders, or any other volatility would amplify the negative operating profitabiliy of the company, as it needs to continue to pay its laborers and researchers, depreciate its capital investments, and have "lights-on" at the plant for the capacity that is being used. [edit] Rise of China's Middle Class will lead to increased consumption of electronic consumer goodsAs one of the world's largest developing markets, the potential for semiconductor consumption in China is huge. For example, China Mobile was adding 5.2MM customers every month in the first half of 2007.[15] SMI has nurtured its relationship with domestic semiconductor companies, and has it advantage as the "local" foundry. At present, approximately 10% of its sales come from domestic chip design firms.[16] Other once-luxury goods that are demanded by Chinese consumers with newly disposable income include computers, cars, and other electronics. SMI is poised to take advantage and gain sales if domestic consumers turn to domestic consumer electronics companies. [edit] Lifting trade restrictions between Taiwan and China has positives and downsides for SMI
The decreased political tensions, and easing of economic restrictions between China and Taiwan opens up the mainland to investment by SMI's chief competitors: Taiwan Semiconductor Manufacturing Company (TSM) and United Microelectronics (UMC). In the past TSM has tangled with SMI legally over IP Theft , and SMIC settled for $175MM.[17] SMI is still getting legal attention from TSM.[18] The opening of borders between the two territories can either allow for increased competition if the competition chooses to grow organically, or a strategic acquisition, if they choose to solve the issue by acquiring the competition. For TSM, this would give them further capability in China, and solve many of the legal issues. For UMC, it would help to purchase manufacturing power in cheaper China. [edit] Company's recent exit from Commodity DRAM business may lead to margin expansionSMIC's low-margin problem is caused dynamic RAM (DRAM), which commands a significantly lower price than other chips, such as processors and graphics chips. In Q4 of 2006, these chips made up 38.6% of revenues.[19] As of Q1 of FY 2008, the percentage has decreased to 12.1%[20] The improvement is not reflected in the financial statements, as the company booked a -9.0% gross margin in Q1 of 2008, but that is partially due to $44MM in one-time losses associated with dropping the DRAM business[21], in conjunction with the high fixed costs of depreciation and labor. If the company is able to book new orders and replace loss utilization, margins should theoretically improve as it fills capacity with higher margin "logic" chips. [edit] Competition
[edit] Market ShareThe total revenues for the global semiconductor foundry market are estimated at $22.2B by Gartner Dataquest[22] and $24.5B by IC Insights for the year 2007.[23] The "Top 4" - TSM, UMC, SMI, and CHRT - are estimated to have 72.5%[24] and 68%[25] combined share of the total market by the two data services, respectively. Below are Gartner's estimates of market share by revenues for the year 2007 with the top 10 semiconductor foundries. By these estimates, SMI had 7% market share in 2007 by revenues, putting it in third place behind competitors Taiwan Semiconductor Manufacturing Company (TSM) and United Microelectronics (UMC).  2007 Semiconductor Foundry Market Share[26]
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