Sunday, December 7, 2008

Slump smacks Taiwan tech

Global downturn has Taiwan high-tech companies reeling
November 20, 2008

TAIPEI: The global downturn has sent the two leading high-technology manufacturing industries in Taiwan - semiconductors and flat-panel screens - reeling, a cautionary tale for technology companies competing in low-margin industries with huge capital costs and extreme cycles of boom and bust.

In good times, the island companies have managed to rake in profit anyway. But their weakness compared with rivals from South Korea and Japan in terms of technology, customer base, scale and currency valuation has become painfully evident during a recent supply glut and, now, a decline in orders from the United States and Europe.

Some Taiwanese technology companies remain in good shape to ride out the downturn. Taiwan Semiconductor Manufacturing retains a leading edge in chip-making technology, for example, and contract electronics giants like Hon Hai are somewhat insulated by their big economies of scale.

The smaller players in lower-margin businesses are most vulnerable, analysts say - companies like the memory-chip maker ProMOS and the flat-panel makers Chi Mei Optoelectronics and Chunghwa Picture Tubes.

For now, the gravest concern is focused on memory-chip makers. Taiwanese firms account for 40 percent of worldwide production of latest-generation dynamic random-access memory, or DRAM, chips, compared with 30 percent to 35 percent for South Korean companies, according to the market researcher DRAMeXchange, based in Taiwan.

The island's capacity edge was made possible by huge capital expenditure, often on credit, in pricey, cutting-edge "fabs," or wafer factories.Now, that spending binge is looking unwise.

The top four memory chip makers in Taiwan - Powerchip, Nanya, ProMOS and Inotera - are expected to lose a combined 112.5 billion New Taiwan dollars, or $3.4 billion, this year, according to an estimate from the Industrial Technology Research Institute in Taiwan. And they are carrying an estimated 420 billion dollars in debt, mostly to local banks.

Powerchip's net debt-to-equity ratio was 1.6 in the third quarter; ProMOS's was 1.7 at midyear - some of the worst numbers in the industry.

Iris Guo, DRAM analyst at Yuanta Securities in Taipei, estimated in a report last month that ProMOS would run out of cash in about three months and Powerchip in about four and a half months without forbearance from banks, new funding or government help.

For now, the government has come to the rescue. On Nov. 10, it directed banks to give memory-chip companies a six-month grace period on repaying debt. The government also injected 100 million dollars more into a National Development Fund, to be used starting next month to help DRAM makers and other troubled companies in any industry to restructure or merge.

But the government said it would not approve new loans for the companies, and would urge the industry to consolidate and increase its competitiveness.

That reflects the government's attempt to strike a balance in its intervention. Analysts say the government is wary of offering life support to money-losing, uncompetitive companies in an overcrowded sector. But it cannot afford to let Taiwanese DRAM makers fail, because their loan defaults could send shock waves through the island's financial sector.

"I think their long-term competitiveness will vanish, but I don't think they'll go bust," said Guo of the troubled island memory-chip makers. "The Taiwan government won't let them go bankrupt, because that would cause a big crisis for Taiwan banks."

Memory chip companies are at a disadvantage in technology, analysts say, because they lease technology from South Korean and Japanese manufacturers and in exchange provide those foreign companies with DRAM chips at below-market cost. That saves research and development and other costs in good times. But it is a punishing pricing arrangement in bad times, when memory chips are selling on the open market at below the cost of production.

"If you don't have technology, you can't drive down costs," said Joyce Yang, an analyst at DRAMeXchange.

ProMOS is a case in point. It leases technology from Hynix, a South Korean company, and in return makes cut-rate chips on contract for its partner. Hynix keeps its own supply flexible by outsourcing some DRAM chip orders to its Taiwan partner ProMOS, giving it extra capacity to fill orders in boom times. In a downturn, it can decrease those orders first.

The DRAM analysts Yang and Guo say this puts Taiwan makers at a disadvantage compared with Korean and Japanese competitors and partners.

Makers of flat-panel screens are also struggling, hurt by a supply glut and flagging export markets that are pushing smaller Taiwan firms to the wall.

Here, too, Taiwan is likely to fall behind the South Koreans. The two countries now evenly divide the majority of the world's flat-panel market, with Taiwan accounting for 44 percent of global shipments of large panels used in TVs and computer monitors, and South Korea 43 percent, according to the market researcher DisplaySearch, based in Taiwan.

But David Hsieh, head of DisplaySearch's Taiwan office, expects the South Koreans to push up their market share to 46 percent by the end of this year, while Taiwan makers fall to 41 percent or 42 percent.

"Korean makers are becoming more aggressive in taking more market share, and that will be a crisis for Taiwan panel makers," Hsieh said.

The depreciated won will make Korean panels cheaper, making it easier for Korean firms like Samsung to undercut the Taiwanese on price and grab market share. As Citigroup's Andrew Lu said, there is also a sourcing issue: Korean companies can stop outsourcing orders to Taiwan in tough times, and "in-source" instead by keeping all orders or filling them from other Korean makers. This will also increase their market share, measured in shipments.

In flat panels, smaller Taiwan companies have a disadvantage in their customer base. The leading Taiwan flat-panel maker, AU Optronics, has somewhat more ability to endure a downturn because its customers include the top-tier electronics names Samsung and Sony. But Chi Mei, the No. 2 manufacturer, mostly supplies Haier and other Chinese TV makers, said Hsieh, and the third-largest maker, Chunghwa Picture Tubes, sells mostly low-margin monitor screens.

Here the benefits of the Korean conglomerates also come into play. The leading Korean flat-panel makers, Samsung and LG Display, have a guaranteed customer base in their own sister firms, which make and sell the finished products. The conglomerates, known as chaebol, also source extra capacity from Taiwanese firms, but as with memory chips, those orders are among the first cut in a downturn.

Huge conglomerates also have deeper pockets to tap in harsh market conditions. This year for the first time, prices for large liquid-crystal-display panels used in flat-screen TVs and computer monitors dipped below production cost. Last month, a 19-inch panel that cost about $72 to $75 to produce was selling for about $70, according to Hsieh.

That especially hurts for a firm like Chi Mei, which went on a spending spree to expand capacity by 40 percent this year over last, according to Pu of Yuanta, only to see the market take a nosedive.

The sharply depreciating won has given South Korean exporters a huge edge over Taiwanese and Japanese rivals. The currency has declined about 35 percent against the dollar this year, making Korean exports far less expensive, while the New Taiwan dollar has only declined slightly, about 3 percent.

Still, analysts do not see Taiwan flat-panel makers failing, either. Even if banks will not extend new loans, each has a parent company that is unlikely to let it fail. Chi Mei Optoelectronics, for example, is part of the sprawling, Taiwan-based Chi Mei conglomerate, and Chunghwa's parent company, Datong, can keep feeding it cash.

Consolidation would be another possible solution. In both the memory-chip and flat-panel sectors, it could create one or two larger companies big enough to compete with the Koreans, instead of a crowd of smaller players.

But analysts say mergers in the memory-chip sector are difficult because each Taiwan company's technology is leased from a different foreign partner. And flat-panel makers have long resisted government appeals to merge.

Lu, the Citigroup analyst, wrote that Taiwan flat-panel makers must merge to remain competitive, allowing them to cut research costs and expenses.

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