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Semiconductors – Teamwork Makes the Dream Work?

21 May 2024

What separates the semiconductor industry from many others is that its value chain is very fragmented and spans numerous companies, most of them with unique competitive advantages.

[First published in the April edition of RankiaPro Magazine]

Based on the Morningstar’s Moat analysis estimates that 65.5% of the industry possesses sustainable long-term advantages (so-called wide moats), while for further 25.9% Morningstar assigns a narrow moat, signaling a possible medium-term edge.

Moat Distribution, %

Source: VanEck, Morningstar, as of 29/02/2023. Analysis based on the MVIS® US Listed Semiconductor 10% Capped ESG Index.

How does this happen? The secret is in the industry’s low degree of vertical integration, where multiple highly specialized stakeholders collaborate to create the end result – a chip.

The process starts with chip design. A company, either an Integrated Device Manufacturer (IDM) that has manufacturing capacity (e.g. Intel or Texas Instruments) or Fabless (outsources production – like NVIDIA or AMD) develops the chip using intellectual property (for example ARM cores) and relevant design software, provided by likes of Cadence or Synopsys.

The design of the chip, also known as mask, is then sent to a factory (so-called fab), which could be an in-house facility for an IDM or a company specializing exclusively in chip production (like TSMC or Global Foundries). Production spans across numerous steps, all requiring complex equipment. It starts with preparing the materials and creating a wafer – a thin round slice of semi-conducting material, usually silicon. Afterwards, the chip design is inscribed on the wafer in a process called photolithography – arguably the most important part of chip production. ASML is the undisputed market leader in the space with 80% of the market share, being the only company that produces EUV machines used for fabrication of the most sophisticated chips.

Then, multiple layers of materials are added using the etching process, ions implanted to improve conductivity or insulation, and the wafer goes through a thorough cleaning and inspection process. This is where machines produced by, among others, KLA, Lam Research and Applied Materials step in. The chips are then cut, packaged and tested using Advantest or Teradyne equipment, before you get the final product. As you can see, the semiconductor industry thrives on many intricate relationships between firms, which would be hard to capture buying only a single semiconductor stock. For those who want to capture the industry in its all complexity, a semiconductor ETF might be a better choice. Nevertheless, investors should pay attention to the high degree of sectoral concentration in such ETFs and be wary of using them as core of their allocation.

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