EL SEGUNDO, CA – Once the world’s fastest-growing chip manufacturing region, China hit an all-time low in the first quarter, with nearly 60% of the nation’s semiconductor manufacturing capacity unused, according to iSuppli Corp.

Semiconductor manufacturing capacity utilization in China fell to 43%, the lowest level since iSuppli began tracking the market in 2000, and a massive drop from a recent high of 92% in the second quarter of 2004. The rate comes as a direct result of low demand spurred by the global economic downturn. However, the plunge indicates China’s long-nurtured goal of establishing a vibrant domestic semiconductor production industry is in serious jeopardy, says the firm.
 
“During the last 10 years, the Chinese government has worked to develop a domestic economy that would provide the nation with economic independence,” said Len Jelinek, director and chief analyst for semiconductor manufacturing at iSuppli. “The establishment of a technologically strong Chinese semiconductor industry was considered an essential element of China’s long-term domestic economic and technological independence. Unfortunately for China, the plan collapsed as global sales dried up before demand generated from internal sources was able to grow to match demand generated from the rest of the world. Once viewed by China’s government as a pillar of growth, semiconductor manufacturing has turned out to be a financial burden.”
 
China’s investments in capacity and technology in the semiconductor sector have not provided the financial returns that were forecast for investors, Jelinek added. Adding to China’s dilemma is the overestimation of capacity, which was expected to be shuttered in other regions in favor of lower-cost, more efficient Chinese manufacturing.
 
“With the addition of the current global economic recession, China’s focus has shifted from establishing semiconductor manufacturing independence to restructuring its entire chip industry before it simply collapses.”
 
China's utilization is expected to rise moderately through the rest of the year, but will remain low at 54% in the fourth quarter of this year. Over the longer term, utilization will rebound to 84 and 85% in 2012 and 2013, respectively. However, when utilization recovers to these levels, China's semiconductor industry will look very different from how it has in the past, with the number of competitors in the industry likely to be dramatically reduced as a result of consolidation.
 
“Since Chinese semiconductor manufacturers do not possess a technological differentiation from their competitors, they are at a disadvantage, since there is simply far too much of the same kind of capacity in the world chasing after the same opportunities,” Jelinek said.
 
“This will lead to mergers and consolidations. However, even if suppliers with similar technologies merge, will they create anything but larger companies with bigger cash-flow problems?”
 
At first glance, such a scenario is most likely what will happen. Nonetheless, there will be one ancillary effect that will significantly impact the landscape of companies in China: The bigger company will be viewed as the most likely survivor, says iSuppli.
 
This perception will transform into reality, as customers assure themselves of a strong supply source by aligning with the largest, most cost-effective semiconductor maker. In the end, the smaller company simply will be forced out because it is uncompetitive in technology and price.
 
With iSuppli not forecasting a recovery for Chinese manufacturers until 2012, it is unlikely weak companies can survive two years in the face of a negative cash flow.
 
iSuppli anticipates the first merger in China’s semiconductor industry will be finalized in the second quarter of 2009. This will signal that time is of the essence if a company or a group of companies is going to be able to weather the storm. iSuppli anticipates that by the second half of 2010, a smaller – yet stronger – semiconductor industry will emerge in China.

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