EETimes.com – Commentary: What’s next for troubled SMIC? (Nov/09)

EETimes.com – Commentary: What’s next for troubled SMIC?.

Commentary: What’s next for troubled SMIC?
SAN JOSE, Calif. — In just one day alone, China’s Semiconductor Manufacturing International Corp. (SMIC) suffered three major setbacks. On Tuesday (Nov. 10), it lost a big patent suit, its chief executive, and, in some respects, its independence.

What’s next? Clearly, change is in the wind at silicon foundry vendor SMIC (Shanghai). Going forward, SMIC’s newly-hired CEO must take swift action and restore customer confidence, bolster its bottom line and possibility change its overall strategy, according to analysts.

Observers believe SMIC will accelerate its 45-nm process R&D efforts, but it will possibly place its focus on fewer markets going forward. It is also likely that the company will end its reckless practice of building and managing fabs for others on a whim.

Another question remains clear: Now that Taiwan Semiconductor Manufacturing Co. Ltd. (TSMC) has gained a small stake in SMIC, will TSMC impose its will on SMIC? And over time, will TSMC buy SMIC–in an effort to expand into China?

Time will tell following a dramatic settlement between TSMC and SMIC. As reported on Tuesday, TSMC reached an out-of-court settlement in its bitter patent suit against SMIC, which clearly lost the case in dramatic fashion.

Under the terms, SMIC will pay TSMC $200 million plus SMIC stock and warrants. TSMC obtained 1,789,493,218 shares of SMIC, representing approximately 8 percent of SMIC. TSMC also obtained a warrant to subscribe for 695,914,030 shares of SMIC, which would allow TSMC to obtain total ownership of approximately 10 percent of SMIC.

TSMC has agreed to certain standstill, voting, and transfer restrictions for so long as they own any of the securities. TSMC will not be granted representation on SMIC’s board and will not be involved in the day-to-day operations of SMIC. TSMC will vote its shares in favor of the actions recommended by SMIC’s board.

Following the stunning settlement, Richard Chang, the founder and longtime CEO of SMIC, resigned. SMIC has appointed veteran industry executive David N.K. Wang to replace Chang. Some say Chang was ousted. ”I would hardly call this a resignation,” according to one analyst.

Steven Pelayo, an analyst with HSBC, said the TSMC settlement could have a dramatic impact on SMIC. ”SMIC will pay $200 million. This is obviously much less than the rumors of (a) $1 billion (settlement),” Pelayo said in a report.

”SMIC currently has about $450 million in cash and is cash flow positive this year and next, so we are not worried about the ability to survive,” he said. ”Our greater near term concern remains the reactions of customers and suppliers, which may impact near term strength. We still like the turnaround story at SMIC, but admit we will need to get this issue behind us and hear 4Q ’09 results (and) 1Q ’10 guidance before the shares can work.”

Regarding the management changes, the news was viewed as positive. ”Shareholders have been very frustrated with SMIC’s performance since IPO (in 2004), thus we believe the news will be interpreted positive,” he said.

Indeed, SMIC continues to lose money. It has never made a dime. It posted third-quarter sales of $323 million, up 21 percent sequentially, but down 14 percent year-to-year. The company posted a net loss for the quarter of $69 million, compared to losses of $98 million in the second quarter and $33 million in the third quarter of 2008.

For the fourth quarter, SMIC said it expects revenue to be between $329.8 million and $339.6 million, which would represent an increase of 2-to-5 percent, sequentially.

For some time, SMIC has claimed that it will turn a profit. And for years, it has failed to deliver on those promises, causing analysts to look at the company’s shares and business practices with extreme skepticism.

Six out of 11 analysts who follow the company have a ”sell” rating for SMIC. That could change, given the appointment of Wang. ”The combo of a likely pullback in the shares and the appointment of a well-respected new CEO may actually drive a few upgrades to the shares,” Pelayo said.

So, what will Wang do as the new CEO at SMIC? Clearly, the new top executive may have to clean house, ostensibly to give customers the appearance that the company has changed its ways.

Chang may not be the only executive to leave under pressure amid the TSMC settlement. The fate of Marco Mora, chief operating officer for SMIC, is unclear.

Mora was the subject of intense scrutiny in TSMC’s recent suit with SMIC. In 2000, TSMC acquired Worldwide Semiconductor Manufacturing Corp. (WSMC), a Taiwan-based foundry. Chang was the president of WSMC, Mora was vice president of operations and Katy Liu was the manager of Q&A. Following the deal, Chang, Mora and Liu become employees of TSMC.

Shortly after that event, Chang left TSMC to form SMIC, TSMC alleged. Mora was the operations manager of TSMC’s Fab 8B, until he resigned from TSMC and joined SMIC in May of 2000, TSMC alleged.

Then, according to TSMC, Mora, who was working at SMIC, allegedly sent e-mails to Liu, who was still working at TSMC. In the e-mail, Mora allegedly requested Liu to ”pull out some of the information from WSMC/TSMC.”

The ”information” that was allegedly taken was TSMC’s secret sauce, including its latest 180-nm technology, among other processes, at that time, according to TSMC. Liu resigned from TSMC in early 2001.

TSMC originally filed suit in December of 2003, about three months before SMIC’s IPO. That suit claimed SMIC had systematically pilfered TSMC trade secrets by hiring hundreds of its engineers and asking a few senior people to take information with them as they left. The two sides settled about a year later.

In 2006, TSMC sued SMIC for breach of a settlement agreement, breach of promissory notes, and trade secret misappropriation. TSMC’s complaint accused SMIC of “massive corporate espionage” and claimed that SMIC “lavishly copied the information it stole from TSMC, word for word, and even typographical error for typographical error.”

TSMC alleged that SMIC incorporated TSMC trade secrets in the manufacture SMIC’s 0.13 micron or smaller process products. TSMC further alleged that the alleged breach terminated TSMC’s patent license made ineffective the covenant not to sue with respect to SMIC’s larger process products.

After the liability phase of the trial, the jury last week found in favor of TSMC on 61 of 65 trade secret claims. Beyond the verdict, what’s next for SMIC?

Clearly, SMIC will continue to pursue its leading-edge, process-technology efforts. It is ramping up its 65-nm process, with plans to ship 45-nm wafers in 2010. SMIC, which is fighting to catch up with the leading-edge semiconductor technology pace set by its rivals, plans to extend its 45-nm bulk CMOS to 40-nm and 55-nm geometries. The 45-nm process is based on technology licensed from IBM Corp.

But going forward, it is unlikely that SMIC will continue to be ”all things to all people.” In other words, some speculate that Wang will focus the company’s efforts on fewer markets.

For the most part, the company’s strategy is to emulate TSMC and offer a broad range of technologies. SMIC’s process offerings include analog, CMOS, mixed-signal/RF, liquid crystal on silicon (LCoS), and MEMS technology. At one time, SMIC even offered a solar foundry process.

It makes sense for SMIC to enter parts of the analog foundry market, such as high-voltage and RF. Many digital designs are moving towards mixed-signal technologies.

But SMIC has no business being in the solar market. Some question why the company is pushing LCoS and MEMS foundry offerings. It offers little or no value for customers in those arenas–the market is too competitive, observers said.

Another questionable strategy is SMIC’s efforts to build and manage fabs for various municipal governments in China. Right now, SMIC is managing two fabs–Cension Semiconductor Manufacturing International and Wuhan Xinxin Semiconductor Manufacturing Corp.Cension is based in Chengdu and run by SMIC. Wuhan Xinxin is based in Wuhan.

It may end up buying back those fabs or scrapping them all together. ”Looking forward, Semiconductor Manufacturing International Corp. (SMIC) very well may acquire Cension Semiconductor Manufacturing International and Wuhan Xinxin Semiconductor Manufacturing Corp., two companies it is managing,” according to a recent report from iSuppli.

Besides the third-party fabs, there are other pressing issues for SMIC. In fact, 2010 is a make-or-break year for the company. First, the company must demonstrate that it can become profitable. In the past, it bought market share at the expense of its bottom line. That practice is no longer tolerable.

SMIC will also be under pressure to ramp its 65-nm process and ship its 45-nm technology–or it will continue to fall behind its rivals. If it fails to execute in 2010, SMIC could be the next victim of the ongoing shakeout in the foundry business.

Several years ago, the company was supposed to merge with Singapore’s Chartered Semiconductor Manufacturing Pte. Ltd. That deal fell through.

Now that TSMC has taken a small stake in SMIC, the ”SMIC-TSMC watch” will move into full force. TSMC claims it will not have a role in SMIC’s day-to-day activities. Others wonder.

In the future, TSMC itself would like to expand its wings in China for good reason: Its customers are scrambling to expand their presence in that nation. The foundry giant has only one ”trailing-edge” 200-mm fab in China. In contrast, SMIC has leading-edge fabs in Beijing, Shanghai, and eventually, Shenzhen.

So far, TSMC and other Taiwan concerns have been prevented from building leading-edge fabs in China. ”During his presidential campaign, (Taiwan) President Ma advocated for a far-reaching relaxation of China chip regulations, but so far his administration has not delivered,” according to the US-Taiwan Business Council.

”Ma has talked about allowing chipmakers to do anything in China as long as they first apply to regulators for permission — that would include building state-of-the-art 12-inch wafer fabs as advanced as the new Intel fab. This policy would be a good move. But since Ma has not changed a single rule on this issue since he entered office, it is hard to see how Taiwan can leap from a very conservative policy to a very open policy all at once.”

TSMC Chairman and CEO Morris Chang and other business leaders in Taiwan could grow impatient with the island’s slow-moving policies. In fact, TSMC’s rival has already thrown down the gauntlet in China. In April, United Microelectronics Corp. paid $285 million to acquire the 85 percent of Chinese foundry He Jian Technology Co. Ltd. that it did not already own.

It’s only a matter of time before TSMC takes a similar plunge–with SMIC as the likely target.

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