Promises of capacity expansion in passive electronic components have resulted in mass skepticism among the financial community in Tokyo, Hong Kong, Taipei, Seoul, Frankfurt and New York. Paumanok Publications, Inc. will soon release a report on capacity expansion in the passive components industry that suggests it is safe to be skeptical. Historically, the market for passive components tends to drop off suddenly and dramatically, much to the chagrin of those who predicted that “this time was different.”
Capacity Expansion Announcements:
Paumanok Publications notes that by the end of Q1 2007 CY new unit capacity in passive components will increase by 20% on an annualized basis. The majority of capacity expansion in units will be for multilayered ceramic chip capacitors (MLCCs), although we note here that the tantalum capacitor industry and the aluminum electrolytic capacitor markets are also increasing unit capacity. Paumanok perceives very little in capacity expansion for DC film capacitors (except for SMD film chips), but substantial activity in expansion of AC film capacitors for use in the automotive industry.
Capex versus Consumption:
The majority of capacity expansion in the passive components industry will be centered upon Japan and China, although Korea, Thailand, Philippines and Malaysia will benefit from the expansion of passive components as well. Production in Europe should increase slightly (because of the auto and wireless tie-in), while production in the Americas and Mexico will continue to decline throughout CY 2007 as U.S. vendors continue to consolidate production in China.
Financial analysts in Tokyo have cited the 20% expansion in MLCC as being consumed in CY 2007 and this is where skepticism begins to take hold for the near term condition of the marketplace. This 20% increase in unit consumption in one year is being slated largely for the wireless handset business, and is supported by only minor growth forecasts in demand from personal computers, consumer AV and automotive electronics. This a lot is riding on handsets.
To support this we note that companies that have greater exposure to handset customers are increasing their unit output by 30% and those with greater exposure to other markets are increasing their output by half that number.
Content per Box Argument:
Analysts in Tokyo are citing a rather sharp increase in demand from the wireless communications industry for CY 2007 because of increased production of CDMA type phones. These devices have higher passive component content per box than a lower frequency-type phone (The increase in content per box is not frequency dependent but functionality dependent — a very important distinction for forecasting).
There is also a larger content of passive components in flat panel displays when compared to cathode-ray tube (CRT) monitors, a larger content of passives in PC dual core processors than in single core processors, and a larger content of passive components in ICG and HEV automobiles.
As we enter Q4 2006, these markets are overheating and consuming record numbers of passive components. In fact, two CEOs from major passive component houses have compared this time to the past boom time of 2000.
These rapid growth markets, along with game consoles and digital cameras, account for 45% of global unit demand for passive components, and there is no doubt that the industry will realize the affects of increased content per box until 2011, when we expect the next expansion to occur.
However, it is the other 55% of the market we are concerned about.
The Other 55% of the Market:
Due to the maxim that every electronic circuit requires capacitance and resistance, we note that passive component consumption is ubiquitous in all electronic devices. While there are rapid growth portions of the industry, these are, in many instances, at the expense of legacy product lines (e.g. CRT monitors, older game consoles, landline phones). Thus, while one part grows, the other declines, affecting passive component consumption as a whole. This is why we have never seen more than 14 months of an up-cycle since 1982.
The “Me Too” Factor:
Many companies fail to plot this scenario and expand at a rate that exceeds their near-term requirements, but makes sense for a three-year or five-year requirement. Many companies expand as a result of the announcements of their competitors, and then again, some companies suggest a larger expansion rate, so their competitors will expand, and then reveal some adjusted number later on. This is occurring right now as a major Japanese MLCC manufacturer attempts to gain back share it has lost to Chinese and Korean competitors since 2000, and perhaps force their Japanese competitors to spend money they do not have right now.
The Historical Drop Off:
As I have noted, since 1982 the up-cycle has lasted no more than 14 months when measured in five-year increments. The 46 months in between are generally marked by limited revenue growth and severe price concessions due to overcapacity. Also, the down cycle usually begins after the first of the year (post Christmas) and is very substantial. Wireless handset consumption drops off dramatically in this month and for the first quarter, and we see no indication from the major wireless manufacturers that this will change in Q1 2007 because of the need for higher functionality phones.
In 2007, I expect the global passive component markets to drop off in the first quarter, stabilize in the second and then to come back strong in the third and fourth quarters. New capacity additions will come on line when the market will be dropping off and this will result in price erosions that will set the stage for the rest of the year. Thus, our value growth forecasts for the passive component industry are much more conservative for CY 2007 then many other financial analysts in this sector.
Price Erosion is the Variable:
In addition, the trend is for price erosion to begin in the first quarter of the new down cycle. Price erosion is directly proportional to the amount of excess capacity in the marketplace. One major portion of the passive component space, the picofarad MLCC market, will experience a substantial increase in capacity expansion at high yield ratios in Japan, China and Korea. And this is where Paumanok Publications differs in its findings from other analysts- this market will decline in value (not grow) and this upsets the value forecasts for major public companies in passive components in those countries.
The price erosion forecasted for the first quarter will set the stage for lower value ratios for the entire year.
Expanding Technology Platforms:
When assessing individual companies for profitability and growth in 2007, we are also interested in expenses related to increasing yield ratios and investments in advanced technology, in addition to their capacity expansions in units.
For some Japanese vendors, for example, investments in unit additions should be secondary to investments in improving yields on the advanced production lines they already have in place. Unfortunately, the perception is that any lack of expansion in the wake of the competition expanding is viewed as a weakness (not by management but by shareholders).
Nowhere is this truer than in high capacitance ceramics, and polymer electrolytic capacitors, where production processes continue to be wasteful and where yield ratios need improvement around the globe. Regardless, a substantial amount of investment in Q4 2006 and H1 2007 will be for increasing unit capacity in the microfarad range for MLCC, and for increasing the capacity to produce conductive polymer tantalum and conductive polymer aluminum capacitors.
Summary and Conclusions:
I remain skeptical about the continued value growth for the passive component industry in CY 2007 as most analysts are saying will occur. I expect excess capacity in key portions of the business, with emphasis upon picofarad MLCC that will result in price erosion, negatively impacting the industry as a whole.
This will limit the market value for the calendar year. I also note that capacity additions in advanced technology are coming at the expense of yield improvements, and many companies would do well to spend just as much money on yield improvements as they do on increasing unit capacity.
There will be rapid growth markets in units in 2007, with emphasis upon wireless handsets (declining in Q1 and then recovering), digital cameras, new game consoles, flat panel displays, and dual core microprocessors; however, this will be offset by declines in legacy markets. Thus, there should be price erosion in Q1 2007 that will set the bar for the rest of the year. The value equation looks much smaller for 2007 when compared to 2006 CY.
Statements of fact and or opinions expressed in MarketEYE by its contributors are the responsibility of the authors alone and do not imply an opinion of the officers or the representatives of TTI, Inc.
Dennis M. Zogbi
Dennis M. Zogbi is the author of more than 260 market research reports on the worldwide electronic components industry. Specializing in capacitors, resistors, inductors and circuit protection component markets, technologies and opportunities; electronic materials including tantalum, ceramics, aluminum, plastics; palladium, ruthenium, nickel, copper, barium, titanium, activated carbon, and conductive polymers. Zogbi produces off-the-shelf market research reports through his wholly owned company, Paumanok Publications, Inc, as well as single client consulting, on-site presentations, due diligence for mergers and acquisitions, and he is the majority owner of Passive Component Industry Magazine LLC.