Q: How Many Global Monopolies Are There In the Semiconductor Industry? | H.E.R.O. Issue 19, 18 January 2021
During the time in teaching management accounting at the Singapore Management University (SMU), I would ask the class to think of an example of a global monopoly so as to illustrate the dynamics between cost/profit behavior, capex budgeting, innovation and the total addressable market. Sure, there are market leaders like Google in search engine and search advertising, but it is difficult to name a global monopoly with 100% market share worldwide. Actually, many of us are familiar with one - even though we buckle and unbuckle them several times during a flight, you might not have given much thought to your passenger seat belt system. Whichever kind of airplane seatbelt and buckle you have, including the thicker built-in-airbag seat belt, they come from one company who is a global monopoly.
Amidst the global shortage for chips that has shut down auto factory lines and stoked up waiting lists for the latest consumer electronics, and the powerful signal this week by foundry leader TSMC in raising its capex to more than US$25 billion this year to scale up its production to meet booming demand that could last for years, who are the global monopolies in the semiconductor industry that stand to benefit?
Again, there are market leaders, such as TSMC, whose industry dominance with over 55% market share and important industry shifts gave the chip foundry leader the power to charge customers more - revenue per wafer is 30% higher than three years ago, compared to a 1.6% increase in prices annually in the five years to 2018. KLA-Tencor and Applied Materials dominate the wafer circuit-pattern inspection equipment market. Entegris is the market leader in products and systems that purify, protect, and transport critical materials used in the semiconductor device fabrication process, help manufacturers increase their yields by improving contamination control in key processes. However, global monopolies in the highly complex world of producing semiconductors are harder to name.
One such company is Dutch-based ASML who has a near-monopoly in making lithography equipment systems, especially the next-generation technology in extreme ultraviolet lithography (EUV), the most advanced fabrication method that is indispensable to reach smaller geometries like 5nm today and 3nm in 2022 to unlock more powerful and efficient chips. Semiconductor processing capacity depends on the line width of circuits, meaning the narrower a line, the more powerful the chip. The utilization of EUV enables a line width of less than 7 nanometers - with 1 nanometer equal to one-billionth of a meter. Thus, four times the number of transistors can fit on a semiconductor with a width of 5 nanometers than on one of 10 nanometers. And ASML's EUV exposure equipment is indispensable in fitting a 5-nanometer circuit on a silicon wafer. The ongoing generational change involving technological advances in the chipmaking equipment market is worth more than US$60 billion annually.
Another is Japan's Tokyo Electron who commands 100% of the market for photoresist coats and developers used in factories deploying EUV technology. There is also a little-known Nordic-listed company with 100% global market share in laser mask writers used in the production of ALL high-resolution displays worldwide, including the upcoming first iMac redesign in nearly a decade, as well as the bigger, AI-enabled automotive touchscreen infotainment dashboard displays with 3D visualizations and augmented reality projections, and expanding to the semiconductor industry.
This week, we highlight two of our portfolio companies who are highly profitable global monopolies in the semiconductor industry: The Only Company in the World that Builds the Testing Machines Required to Verify Chip Designs for the EUV Chipmaking Method of Advanced Chips, which is up +2.5%, and The Global Leader in High-Purity Speciality Chemicals Essential for Advanced Semiconductor Manufacturing, which is up +0.2% during the week (11 to 15 Jan 2021). These rising dividend-yielding profitable and cashflow generative innovators have also compounded 51-fold and 22-fold in capital gains respectively in the recent five years vs MSCI ACWI World index +77.9%.
MONOPOLY #1: Semiconductor Mask Blank Inspection System
Consumers take it for granted that gadgets will keep getting slimmer, more powerful and cheaper, but the chip companies are running out of ways to etch ever smaller circuit patterns onto silicon. After two decades in development, EUV is the long-awaited next generation of semiconductor-making to pack even more transistors within every processor. It promises to unleash another wave of gadgets that are slimmer, cheaper and more powerful. The technology works by moving laser on squares on a very small scale, smaller than the width of a few strands of DNA. By shining ultraviolet light with short wavelengths through the squares to draw design patterns on wafers, circuits smaller than the width of a few strands of DNA are imprinted onto silicon wafers in a process called lithography. Masks, which sandwich about 80 alternating layers of silicon and molybdenum and can cost as much as US$100,000 each, have until recently been a major sticking point.
The Yokohama-headquartered innovator is the only company in the world that builds the testing machines required to verify chip designs for the EUV chipmaking method of advanced chips, commanding 100% global market share in the semiconductor mask blank inspection systems.
Spotting mask flaws is key to increasing yields and making EUV commercially viable, because even a tiny defect can render an entire batch of chips unusable. The innovator's machines can spot problems early on, which is critical to making the technology cost competitive. Under the leadership of CEO Mr. O, the company took six years to develop the mask-testing technology. In 2017, the company solved a key piece of the EUV puzzle when it created a machine that can inspect blank EUV masks for internal flaws. In September 2019, it cleared another milestone by unveiling equipment that can do the same for stencils with chip designs already printed on them.
If you look carefully, you can always find two intertwining plot lines in the story of any business success or failure. The first, and most visible, is the external story. This is the narrative that plays out in the marketplace in the form of earnings, returns to shareholders and profitable growth. This is the story that is “easiest” to track - if one is hardworking enough. It’s a story about how a company wins on the outside by serving the customer better than anyone else in its field.
The second story plays out inside a company. It’s much less visible. It’s the quiet story of building the business and developing a culture that fosters innovation - we focus on this H.E.R.O.’s Journey.
“Let's launch a product every year that is totally new to the world,” founder Mr. U said with a quiet resolve. The origin of the company dates back to 1960 when Mr. U founded a small firm to develop X-ray television systems. His engineering spirit has been held dear and left a lasting organizational imprint since its founding days in bearing fruits in unique and indispensable products that became the de facto industry standard. In 1976, the company was the first in the world to develop mask defect automated inspection equipment for semiconductors, followed by the world’s first color laser scanning microscope in 1985, and the world’s first phase shift measurement system in 1993. In 2017, it was the first - and remained the only - in the world to use EUV light source to detect blank defects. Guided by the corporate philosophy, “Create Unique Solutions. Create New Value”, the company has grown steadily, bringing a number of innovative mission-critical inspection and measurement systems to market, which play an important role in enhancing productivity and reliability of semiconductors and flat panel displays.
MONOPOLY #2: High-Purity Chemicals in Advanced Semiconductor Manufacturing
In semiconductors, circuits for storing information called memory cells are laid out in billions of units along with wiring. In order for this mechanism to function properly, each memory cell must be separated by an insulating film and processed so that each cell does not interfere electrically. The material of the insulating film required is one of the products that this quiet global technological monopoly worked on. Every year, semiconductors are becoming smaller. High-purity materials are required for insulating films, but due to their nature of being used in the miniaturized world, not a large amount of "quantity" is required. On the other hand, in the production of insulating film materials, high-precision equipment and state-of-the-art technology are required because it is necessary to properly mix dozens of chemical substances under special conditions and synthesize only the necessary chemicals.
Enter the global #1 near-monopoly leader in high-purity, specialist chemicals essential for advanced semiconductor manufacturing. Based in the small town of Uenohara with an estimated population of 23,000 folks and located in the Yamanashi prefecture, this quiet innovator also manufacture the special containers essential for storing and selling the specialized chemicals, as well as the peripheral devices that accompany the containers, such as liquid-level sensors. The company also design and manufacture high-purity special chemicals for optical fiber manufacturing and solar cells manufacturing. The company is also experiencing exponential growth in its 35%-owned JV with Korea’s SK Group with long-term locked-in contract with major semiconductor makers Samsung and Hynix.
The company was founded in Dec 1978 by Mr. T, who is the largest single shareholder with a 13.32% stake, who persevered with his early vision that: “Semiconductors are required to be permanently miniaturized as their destiny, but with the process change at each time, the need for new special chemicals will come out.”
Because of the niche yet growing global market, and its extremely high technical barrier to entry as a result of its unrivalled cutting-edge analytic and R&D capabilities in high-purity chemical materials used in cutting-edge semiconductors, both major chemical manufacturer and startups are unwilling and unable to compete with the company. The company's unique business model has mastery of the multi-product and small lot production to meet the demand of customers, and to also quickly respond to the mass production needs of these customers. The company has also forged long-term partnership in co-R&D with customers. In addition to simply selling existing products, the company conducts R&D synthesis of new chemicals and various contract experiments to evaluate the properties and performance of products under the conditions in which its customers actually use them. The development of state-of-the-art semiconductors with high performance and high integration is progressing. New specialized chemicals are indispensable to meet this structural trend and demand.
CEO Mr. T shared: "When you think of chemical manufacturers, many people think of mass production in large-scale facilities such as huge plants and complexes, but as you can see, our factory is not that big. The main reason is that the chemicals we make are "small amounts". For example, when developing next-generation semiconductors, various chemicals are used in the process of selecting what new processes are required and what new materials are needed, but some of the special chemicals are ordered in only 25cc (less than one plastic bottle) from one company. However, even with such a small amount, it is an absolutely indispensable chemical for the production of customers' products, and there are many things that only we can provide. We've been expanding our business by ensuring that we can respond to small amounts of inquiries and continue to focus on making high-quality chemicals that meet customer requirements. Currently, about 20 items cover more than 80% of sales, but while some chemicals compete with other companies, others do not. In other words, there are competitors in some parts of the business, but there are no complete peers, which is a big strength. Major companies will not continue to produce small amounts of chemicals that are not commensurate with the scale of their equipment, and special chemicals will require years of know-how, so no other company in the industry will show up in the future."
CEO Mr. T summed up: "With the expansion of IoT and AI and the introduction of 5G communication, we expect the evolution of semiconductors to continue, and the need for new chemical development to increase. New and large markets will emerge due to the need for new materials and the growing demand for higher performance.”