Price war to beset fabs

Loomis Sayles & Co sold its stake in Taiwan Semiconductor Manufac-turing Co (台積電) last month, saying earnings prospects didn't justify a higher price for the No. 1 supplier of made-to-order chips. The move was just in time: Analysts are beginning to conclude that the advent of startups into the chipmaking business is the beginning of the end of the prevailing business model for foundries.

TSMC shares fell 10 percent between March 26 and April 1 after its largest customer, Nvidia Corp, asked International Business Machines Corp to make its latest graphics chips. TAIEX fell 3.5 percent in the same period.

TSMC's loss highlights the chipmaker's dilemma as it fends off competition from the likes of IBM, which says it has a technological edge, and newer rivals including Shanghai-based Semiconductor Manufacturing International Corp (SMIC, 中芯國際集成電路), which say they can make chips for less.

"With IBM's entry into the foundry business and Chinese companies attacking the lower end, the Taiwanese appear to be getting squeezed from both ends," said John Litschke, who helps manage US$600 million of stocks at Loomis in San Francisco, which sold the TSMC stake about three weeks ago.

A sign

Nvidia's decision to turn to IBM is a sign of things to come.

By 2006, Nvidia, the world's largest maker of graphics chips with US$1.9 billion of sales in the year ended January, will send half its chipmaking orders to IBM, Pacific-Crest Securities Inc analyst Michael McConnell wrote in a note to clients, citing information Nvidia gave to analysts after the IBM announcement.

TSMC, like IBM, is one of only a handful of chipmakers able to make chips from 12-inch (300mm) wafers, cutting costs by producing more chips from a single piece of silicon.

What concerns Loomis's Litschke and George Wu (吳裕良), an analyst at Primasia Securities Co, is that competition from IBM or newer entrants in the US$8 billion a year foundry market such as SMIC may force the Taiwanese chipmakers to lower prices.

"If IBM expands capacity like crazy, there will be severe price competition," Wu said. "That will erode profitability and will be the end of the foundry business model."

More pie pieces

Competition is already starting to splinter the market.

TSMC, United Microelectronics Corp (UMC, 聯電) and Singapore's Chartered Semiconductor Manu-facturing Ltd (特許) collectively will account for about 81 percent of the made-to-order chip business this year, down from 92 percent last year, according to Wu.

A delay in the chip industry's recovery promised to benefit made-to-order chipmakers as more companies accelerated outsourcing or pared expansion plans.

The difference now is that established made-to-order chipmakers like TSMC must cope with start-ups such as SMIC, Silterra Malaysia Sdn in Malaysia and Grace Semiconductor Manufacturing Corp (宏力半導體).

SMIC has already inked agreements to produce chips for Japan's Toshiba Corp and Infineon Technologies AG, Europe's second-largest chipmaker, albeit for memory chips, which TSMC doesn't make.

"The last thing the foundry model needs at this stage is more competition," said Charles Isaac, a fund manager at Swissca Portfolio Management AG, which manages the equivalent of US$32 billion, including shares of TSMC and UMC.

IBM may have reasons of its own to seek out new customers.

Outsourcing