Has there been a technology "leap" in the semiconductor market?

Some people think so. But should investors go along for the ride?

Earlier this year, George Scalise, the president of the Semiconductor Industry Association, was issuing talking points to the press over the relative health of the semiconductor sector.

Much of it was boilerplate -- 2006 was the “year of the consumer” in the electronics industry, he said, which begs the question what year isn’t the year of the consumer in the electronics industry – but some of his comments hit their mark.

Thanks to a perfect storm of new, in-demand technology products like cell phones, MP3 Players, and HDTV sets that all have benefited from the lower-cost, high-functionality trends in the semiconductor industry, the sector is, well, back in the chips these days.
According to the SEI, global sales of semiconductors soared to a record $247.7 billion in 2006, an up-tick of 9% over the $227 billion reported in 2005. Projected numbers for 2007 look even stronger.

One theme of Scalise’s bears watching for investors for the duration of 2007 and in 2008 - - that the short-term future of semiconductors is attached to the electronics market like a barnacle to the hull of a boat. Scalise points out that the semiconductor content of electronic systems has been rising steadily for years now, and today stands at about 21.6%, as measured by cost.

Says Scalise; “Cell phone shipments exceeded one billion units in 2006. The average semiconductor content of a cell phone fell slightly to around $40 last year, mainly due to demand for low-end phones in emerging markets. (But) growth of cell phone subscriptions in emerging markets continues to be strong. 

He says the same about MP3 players and HDTV’s. “More than 34 million MP3 players were sold in the U.S. in 2006 with about 40 million targeted for 2007. While the growth rate for MP3 players is likely to slow going forward, the semiconductor content of these devices is growing as a result of increased storage capacity and addition of new functionality such as video capability. And indications are that U.S. sales of HDTV units more than doubled in 2006 driven by sharply falling prices and increasing high-definition programming. We expect demand for HDTV monitors will continue to grow sharply for the next several years.” 

Overall, the SIA says growth in the semiconductor market for 2007 and 2008 should continue to rise, with an estimate of $273 billion in global semiconductor sales in 2007 and $309 billion in 2008.

The big chip developers have a well-stocked pipeline - - maybe too well-stocked in the eyes of industry analysts who fear a glut of inventory will crimp profits in the chip sector in 2007. Chip companies are also pouring billions into research and development to ensure growth potential for the long haul. Intel, for example, has created a new metal-gate transistor that boasts a 45 nanometer core that fits 820 million transistors on a single quad-core model. That means more processing power for cell phone or electronic toothbrush users but with less battery power needed.

Some analysts believe we are on the verge of 24-hour lap top charges and much more user-friendly and dependable portable video phones, based on new chip technologies like Intel’s. How much of an improvement we will see always seems to be the bugaboo for technology investors but Intel says this time, at least, the change is both huge and revolutionary.

Boasts Gordon Moore, Intel co-founder, "The implementation of high-k and metal gate materials marks the biggest change in transistor technology since the introduction of polysilicongate MOS transistors in the late 1960s"

Perhaps that’s why a slew of investment firms, most notably JP Morgan, are betting that the semiconductor market, after some rough sledding, profit-wise, is in a for a banner year in 2008.

Last week, J.P. Morgan upgraded its stance on the U.S. semiconductor sector to bullish from cautious, saying that several leading indicators are bottoming and have improved through the first half of 2007. "(But) we remain cautious on the PC space and both Intel and AMD, as we continue to believe another inventory correction will occur in the PC component market," said a report from Morgan tech analyst Christopher Danely. In his assessment, Danely suggested that key indicators like gross margins, utilization rates, and earnings estimates are “bottoming out” in the semiconductor marketplace.

According to Danely, the semiconductor industry is in the middle of an inventory correction, which effectively ended during the second quarter of 2007. That should pave the way for higher growth during the last three months of 2007 as margins begin to recover and demand improves seasonally.

Danely is not alone in that assessment. Deutsche Bank, analyst Nicolas Gaudois has upgraded the semiconductor sector to "overweight" from "neutral." "After a year of fundamental deterioration and share price underperformance, we believe investors should begin to increase their exposure to the semiconductor sector as fundamentals should bottom in 2007 and valuations appear attractive," Gaudois said in his own report..
With semiconductors poised for a rebound and electronic company’s looking to bolster consumer demand for their products, both 2007 and 2008 should be an interesting and profitable year for chip companies.