The Semiconductor Industry serves as a driver, enabler and indicator of technological progress. Developments in the industry determine the way we work, transport ourselves, communicate, entertain ourselves and respond to our environment. For example, the PCs we work on, the cars we drive, the phones we communicate with, the electronic gadgets on which we watch movies, listen to music and play games on, and the planes and weapons used to transport or protect us use semiconductor devices.

The consumer electronics market is growing in importance, especially gadgets such as LCD TVs, blu-ray players, smartphones and netbooks. The problem with this segment being a major driver of revenue is its inherently low margins. Competition is fierce and aggressive pricing is the rule of the day. Since semiconductors made for consumer goods are in the nature of components, there is ever-increasing pressure on their prices that correspondingly squeeze margins. According to the Consumer Electronics Association (CEA), the 7.8% revenue decline in 2009 was entirely on account of weaker pricing, as unit volumes of consumer goods increased around 10%. The CEA has revised upwards its initial expectations for 2010 and now expects the market to grow 3% in 2010 to $174.9 billion, compared to previous expectations of $165 billion. Total revenues are expected to reach $182 billion by 2011.

Mobile computing platforms, such as notebooks and tablets are expected to grow into the main drivers of market growth by next year, reaching $26 billion in shipment revenue. According to previous estimates, notebooks alone were expected to generate $14 billion in 2010. The other major driver is expected to be wireless handsets (contributing $26 billion in profits by 2011). Smartphones remain the major driver here, with shipment units reaching 54 million by year-end (previous estimate 52 million). By 2011, the CEA expects shipments to reach 66 million and generate $19.6 billion in revenue. The pricing pressure on digital displays is expected to continue, although volume expectations were doubled to 2.1 million. More than 6 million units ($7 billion in revenue) are expected by 2011. Other growth areas will be 3DTVs, Blu-ray players and eReaders.

Communications infrastructure spending is currently focused on 3G and 4G rollouts. In the U.S., 4G spending is at its peak, with Sprint (S) in the process of rolling out its network and Verizon (VZ) and AT&T (T) ramping up spending. In China, the three major carriers, China Telecom, China Unicom and China Mobile, are rolling out their 3G networks. Spending on 4G has yet to gain momentum. In India, carriers such as Bharti Airtel and Vodafone are also rolling out 3G infrastructure. Increasing data volumes and higher data speeds are primarily responsible for the rapid adoption of new technology in this market. Consequently, semiconductor companies with a communications infrastructure focus should see good growth opportunities for the rest of the year and in 2011.

"Light vehicles" is the section of the automotive market that primarily consumes semiconductors. Gartner expects this segment to grow 13.5% in 2010 to 67 million units (production had slipped 11.8% in 2009). The overall market for semiconductors serving the automotive market is expected to grow 23.5% in 2010, following a 21.7% decline in 2009. Further evidence of a recovery is in the stabilization of inventories, which started declining towards the end of 2008. China is one of the fastest growing markets for automobile production, having contributed 20% of global production in 2009. Semiconductor manufacturers serving this market have a few advantages.

The most important is the growing electronic content per vehicle, driven by the need for fuel efficiency, entertainment and automated navigation. The fact that an automobile model has a significantly longer life than a consumer device model is an added bonus, as once a semiconductor has been designed in, it continues to generate revenue for a number of years. This leads to a stable business model. Infineon Technologies, NEC Electronics, Freescale Semiconductor have significant presence in the automotive market and should see strong growth going forward.

The aerospace and defense markets depend on government spending and policy making and current trends indicate that the strength in defense spending will continue. However, current spending continues to be targeted at terrorist activity, so spending on intelligence systems, surveillance systems and reconnaissance systems remain in focus. Companies offering sophisticated weapons are not doing as good. Commercial aerospace remains affected by tight lending conditions, although the situation has started improving. Demand has increased rapidly, due to growing traffic across the world. So semiconductor manufacturers serving these markets are seeing gradually improving results.

The demand for greater functionality in smaller and more power efficient gadgets is leading to greater integration within the semiconductor device. This is leading to increased demand for the system-on-a-chip (SoC), which is a single device incorporating a microprocessor, digital signal processor or graphics core, as well as memory and logic. Within SoCs, both application specific integrated circuits (ASICs) and application specific standard products (ASSPs) are expected to do well. ASICs are usually customized for a single buyer, while ASSPs may have multiple buyers.

According to Gartner Dataquest and iSuppli Corp, Intel Corp. (INTC), Samsung and Toshiba Corp were the top three semiconductor suppliers in 2009. Texas Instruments (TXN) remained in the fourth position, as the company continued to phase off its wireless baseband business. STMicroelectronics (STM) was in fifth position, followed by Qualcomm (QCOM), which rose from the eighth position in 2008. Hynix also gained, moving from the ninth position in 2008 to the seventh position in 2009. Japan's Renesas slipped a couple of places to number eight. Applied Micro Devices (AMD) re-entered the top ten at number nine, followed by Sony (SNE), which slipped a few places to end at number ten.

VLSI Research estimates that semiconductor equipment sales by the top ten suppliers declined 38.2% in 2009, following a 26% decline in 2008. Therefore, the segment has shrunk by over 50% over the past two years. North American suppliers declined 36.9%, Japanese suppliers declined 35.6%, while European suppliers declined 44.5%. However, despite the difficulties related to the recession and the new trend of equipping fabs with used materials, Applied Materials (AMAT) easily maintained its number one position in 2009. Tokyo Electron Ltd moved from the third to the second position, exchanging places with ASML Holdings N.V. (ASML). Nikon Corporation was at number four, followed by KLA-Tencor (KLAC) and Lam Research Corp. (LRCX). The other players in the top ten included Dainippon, ASM International N.V. (ASMI), Novellus Systems, Inc. (NVLS) and Teradyne, Inc. (TER) in that order.

The Foundry segment went through a major change in 2009 according to recently-announced research from IC Insights. Although Taiwan Semiconductor Manufacturing Company (TSM) remains the leader by far, followed by Taiwan-based United Microelectronics Corp. (UMC) and Singapore-based Chartered Semiconductor Manufacturing (CHRT), the fourth position has gone to GlobalFoundries, which commenced business in March last year. Semiconductor Manufacturing International Corp. (SMI) of China was pushed to the fifth position.

We are, however likely to see increased use of old and refurbished equipment. Among the equipment suppliers, we particularly like Applied Materials, not just because it is one of the largest equipment makers, but also because of its position in the solar device equipment market, as well as its existing refurbished tools business. Granted that there are some issues in the solar business right now, but we remain positive about longer-term prospects. We are also optimistic about KLA-Tencor (KLAC) and Novellus Systems (NVLS) and believe they will do well both in terms of revenue and profit growth in 2010.

Our favorites in this area include Texas Instruments, Linear Technology (LLTC), Analog Devices (ADI), Semtech Corp. (SMTC), Intersil Corp. (ISIL) and Maxim Integrated Products (MXIM), which are seeing very strong demand. Although some of these companies could see a faster recovery than others, they are, for the most part, highly diversified, high-margin businesses. Hence, the sector should do very well in 2010.

The Asian foundries will operate at full capacity this year, but order fulfillment could still be a challenge due to low investment in capex during the recessionary environment. Consequently, we believe that foundries, such as Taiwan Semiconductor (TSM), United Microelectronics Corp. (UMC) and Semiconductor Manufacturing Int'l (SMI) will see limited upside this year, despite very strong demand. Similar will be the position at memory manufacturers, such as Micron Technology (MU) and Hynix.