CHIPS: Megatrends and Mega Funding

CHIPS: Megatrends and Mega Funding

16 Apr, 2024 | Market Insight

We first highlighted the importance of semiconductors back in April 2023 when we introduced the concept of megatrends. Back then, we used the example of the automotive industry and the increasing adoption of electric vehicles (EVs), and highlighted how investing in the “picks and shovels” of an industry can often lead to substantially higher returns for investors. ​


Semiconductors Primer

As we discussed, semiconductors are a unique substance that can operate as both an insulator (it prevents the flow of electrical charge) and a conductor (it can carry electrical charge). Semiconductors are produced from pure elements like silicon or germanium, or compounds such as gallium arsenide, and then treated through a chemical process known as “doping” that enhances conductivity. These chips perch on wafer-thin stages where their properties of conduction (like metals) and insulation (like rubber), let them steer electrical signals to lay the cornerstones of today’s technological evolution.

By combining semiconductors with insulators and other materials, engineers can precisely control the movement of electricity. They are therefore invaluable components in a host of electronic equipment such as computers and other consumer electronics, telecommunication devices, and automobiles. There are semiconductor manufacturers that focus on niche industries or even specific products, there are more diversified semiconductor producers, and there are also a range of companies that provide associated technologies.

A New Wave of Innovation

The evolution of semiconductors over the last fifty years has been truly transformative. They have evolved with and enabled personal computing in the 1990s, the Internet in the 2000s, smartphones in the 2010s, and now, are a key in the emerging “Internet of Things” (IoT) megatrend. This involves embedding everyday devices (air conditioners, washing machines, etc.) with sensors, software and other technologies to enable them to send and receive data (that is, interact with the Internet).

Breakthrough technologies such as 5G networks, EVs, and artificial intelligence (AI) have only accelerated these trends and led to a new era of progress for the semiconductor industry. In fact, consulting agency McKinsey foresees only continued growth in semiconductor demand, with it poised to become a US$1 trillion industry by the end of the decade.

America on the Fringe

Unfortunately for where this all began, the United States is no longer at the forefront of this wave of innovation. According to the U.S. Department of Commerce, the U.S. today is only responsible for the production of just 12% of the world’s semiconductors–down from 37% in the 1990s. This is believed to be largely a result of a decline in government investment, with research and development spending on semiconductors holding largely flat relative to GDP while other countries have significantly ramped up their investments.

Taiwan is the undisputed leader of semiconductor manufacturing as a direct result of the aptly named Taiwan Semiconductor Manufacturing Co. (NYSE: TSM), which is believed to produce up to 50% of the world’s total semiconductors. It operates a foundry business model, where it produces chips for a number of other companies such as Apple, AMD, Qualcomm, and as we have previously mentioned, NVIDIA.

South Korea is also another semiconductor powerhouse, largely owing to Samsung Electronics Co (KRX: 005930), which contributes a staggering 20% of the country’s gross domestic product (GDP). Samsung also operates a foundry producing semiconductors for other companies, as well as operating as an integrated device manufacturer (IDM), producing semiconductors to use in its own range of products, such as home appliances.

Other major countries involved in semiconductors are Japan, which is home to more than 100 semiconductor fabrication plants, and of course, China. China is the world’s largest market for semiconductors thanks to its manufacturing prowess, and the Chinese government has stated its intentions to expand the country’s capabilities with the intention of eventually becoming self-reliant (that is, producing all the semiconductors it requires within China and not requiring any imports). This could lead to China producing up to one-quarter of the world’s semiconductors by 2030.

Enter the CHIPS Act

The U.S. has increasingly pursued an America-first agenda, most notably since the Trump administration when Donald Trump used a more aggressive stance towards China, resulting in a so-called trade war (this included, among other things, the alleged theft of intellectual property). Since this time, geopolitical tensions with China have only deteriorated, partly as a result of China’s stronger commentary towards Taiwan.

This increased geopolitical tension, combined with severe supply chain disruptions during the pandemic and the economic potential of a growing semiconductor industry led to the Creating Helpful Incentives to Produce Semiconductors and Science Act of 2022 (CHIPS Act).

Passed into law in August 2022, the CHIPS Act is designed to strengthen the domestic U.S. semiconductor industry (research, design and manufacturing) as well as enhancing national security.

Specifically, the CHIPS Act provides approximately US$278 billion in total funding between 2022 and 2026. This includes a range of different programs, the most notable of which are STEM (science, technology, engineering and mathematics), R&D, and workforce and development program authorisations for the National Science Foundation, U.S. Department of Energy and U.S. Department of Commerce, and advanced manufacturing tax credits and loan programs.

The Act is already having an effect. Micron Technology (NASDAQ: MU) has announced a US$40 billion investment in memory chip manufacturing (critical for computers and electronic devices), which is expected to create up to 40,000 new jobs in construction and manufacturing. This investment alone is expected to increase U.S. memory chip production from less than 2% today to more than 10% over the next decade.

Taiwan Semiconductor Manufacturing, too, recently announced it had received US$6.6 billion in grants and US$5 billion in loans to boost U.S. production of advanced semiconductors in Arizona, while Intel (NASDAQ: INTC) inked a deal for US$20 billion in combined grants and loans, and Samsung a further US$6 billion.

The TAMIM Takeaway

Identifying companies that are poised to benefit from megatrends is a great strategy for finding long-term investment winners on the share market. There is no doubt that increased demand for semiconductors is one such megatrend as the world moves into a new era fuelled by EVs, 5G, cloud computing and AI. For U.S.-focused investors, the CHIPS Act looks only set to compound this trend, providing enormous incentives for companies to increase their development and production of advanced semiconductors in America. While some may have reservations about the level of the U.S. government deficit and growing debt level, the US$278 billion of funding for the CHIPS Act certainly provides an opportunity for investors.