Why the Chipmakers Are Down for '07

Semiconductor companies are bullish about 2008. But first, they'll have to contend with loads of challenges this coming year

by Arik Hesseldahl

Semiconductor companies may be looking forward to a boom year in 2008, but first they'll need to struggle through 2007—which is shaping up as anything but great.

The beginning of January typically signals a seasonal slowdown in demand for chips used in PCs, digital cameras, wireless phones, and other popular consumer-electronics gadgets. And it usually takes two quarters for that demand to heat up again in anticipation of another tech-crazy holiday season.

But as with every year in semiconductor industry history, there are always a few unusual factors that knock the cycles off a tidy, predictable course. This year, two unusual factors stand out: the demand for flash memory and Microsoft's (MSFT) new operating system, Windows Vista. In the case of flash, chip makers can't keep up with demand, but prices aren't growing fast enough to keep manufacturers very content.

Then there's Vista. It's not the first time that high hopes for the revival of a stagnant PC industry have been pinned upon a new version of Windows. And the last time, what revival there was took much longer than expected to materialize. In short: Don't hold your breath.

Bye-Bye, Hard Drives?

Depending on who you ask, there are anywhere from a dozen to 17 different semiconductor factories, or "fabs," that are either under construction or being converted to produce a type of flash memory chip known as NAND-type flash. It's widely used in digital photography and portable media devices such as Apple's (AAPL) iPod nano and shuffle players.

"There are a lot of companies getting into flash," says Brian Matas, a researcher with IC Insights, a Scottsdale (Ariz.)-based chip-market research firm. "There are a lot of joint ventures getting off the ground, and a lot of companies that make DRAM memory chips for PCs converting their factories to build flash."

Additionally, more demand may come from PCs, as PC manufacturers— hunting for ways to hasten boot times and make notebook PCs less susceptible to data loss from hard-drive damage—begin designing flash memory chips into computers. Many contemplate the days when they can replace the hard drive completely. "I don't know if the market is ready for that yet," Matas says. "I'm also not sure if the cost benefit is there with flash memory yet."

Skirmishing for Market Share

Even so, there's no question the flash business is one hot sector of the chip industry. The most visible example is the joint venture between Micron Technology (MU) and Intel (INTC) to build flash memory chips. But others include collaboration between Europe's STMicroelectronics (STM) and South Korea's Hynix Semiconductor. Meanwhile, SanDisk (SNDK) and Toshiba (TOSBF), which jointly operate a NAND flash factory in Japan, have another one coming online soon, Matas says.

And while revenue for NAND flash chips grew at a healthy 13% clip in 2006, to about $21 billion, that modest sales growth wasn't reflected in unit demand, which grew at a more robust 48%. Matas says 2007 will look fairly similar to 2006, with demand for chips growing at about 27% while prices grow at a relatively slower 14%. "The factories coming on line in 2007 will add a lot of capacity, allowing companies to cut their costs at the same time," he says.

Also in 2007, the fight for market share between Intel and rival Advanced Micro Devices (AMD) will remain as nasty as ever. Intel, it seems, will look to holds its own against an increasingly aggressive AMD. In a Dec. 6 research note detailing a survey of the PCs and servers built by Hewlett-Packard (1 2 Next Page