Data Centers Part IV: Addressing the Looming Threats to Analog – Capacity & China

The TD Cowen Insight

Massive investments are being made at leading-edge semiconductor facilities in a geopolitical "AI arms race," but the over USD 200 billion mature-node market is similarly seeing supply side disruption marked by increased investment, particularly in China. In this report, we analyze implications on long-term supply and demand of mature node semiconductors and where there is the most risk of disorder from China investment.

Our Thesis

The economic and geopolitical importance of "legacy" semiconductors has been illuminated by shortages that disrupted global supply chains in multiple industries. We have written extensively about the fundamentals of these shortages in previous initiation reports. The industry has reacted by meaningfully increasing capacity investment.

At the same time, China has been cut off from equipment needed to manufacture leading-edge digital semis with its goal of self-sufficiency in more mature technologies emboldened. Investors are understandably concerned that structural overbuild could disrupt supply and demand equilibrium driving pricing pressure and underutilization.

Our industry-wide supply and demand model suggests mature node semis capacity will not fall victim to structural oversupply as we forecast through-cycle utilization rates around optimal 80% levels. Increased investment and a modest move back toward internal manufacturing from foundries will inherently drive more cyclical revenue and margins. However, we argue this will be countered by growing exposure to less price-sensitive and stickier auto and industrial sockets at the expense of consumer-facing verticals that were larger drivers of growth in the 2000s and 2010s.

China's market share to date is limited, but its semicap Wafer Fab Equipment (WFE) spending has not been. Progress should be monitored closely given its potential to disrupt our more benign supply and demand conclusions. We examine trends by component and application exposure across the space, as not all risk is created equally.

What Is Proprietary

We built a comprehensive model to forecast capacity by component group, process node, and geography, indicating ~4% growth for analog and trailing edge logic and discrete capacity through the decade against our estimate of high single-digit (%) demand growth. Our forecast indicates utilization near 80% through-cycle not predicated on a sharp cyclical recovery near term.

China has gained less than 200bps of market share over the last two years, but there are important differences by component and end market. We deconstructed China's share gains to date and where capacity is being built to inform our view of where there is more industry risk and insulation. We also estimate that China's semiconductor ambitions are currently accounting for ~30% of industry-wide WFE across products.

What To Watch

• Reaction to cyclical swings on capacity investment: Near-term demand volatility may prompt some chip companies to temper investment, while others take longer-term views.
• China's ongoing investment and market share: China's ambitions to serve automotive and industrial markets poses a risk to long-term growth of Western suppliers.
• Global policy support for semiconductor capacity investments: Cheap or free capital financing will spur new greenfield projects.
• Silicon carbide substrate and device output progression: China still lags Western substrate output but is investing heavily.