The only thing that's clear at this point is the fuzziness of the second half. Both of the foundries are betting that the hot season for electronics will bring a little fourth-quarter cheer, but to what extent and whether it will be sustained, no one is certain.

"We need some new applications to create new demand," said Peter Chang, CEO of foundry operations at United Microelectronics Co. (UMC) "Before that happens, any small signal that indicates recovery is just temporary. It's just a blip. It could be that one month one customer has an urgent need, but then the next month it's gone."

In an uncharacteristic move, UMC has been quite frank about the trouble the company is facing during this downturn. In June, UMC said it would lose money in the second quarter and predicted the third could be even worse. "This is nothing you can hide from," Chang said. Customer forecasts are "very poor" and somewhat unreliable, making it difficult to see how things will shake out in the second half. "The thing is that one month could be better, and then the next is worse. . . . So when I see the forecast, it's the lower number that I usually trust better. The high number I always question."

Doubt is in ample supply across Asia, except perhaps in China, where the economy is still expected to grow by more than 7 percent this year. Everywhere else, there's a dearth of such fortune. Taiwan's growth is at a 26-year low, and its IT industry is set to contract for the first time ever. Japan is still mired in recession. And exports in South Korea's IT sector spiraled downward 25 percent year-on-year in May-within the semiconductor and component sector the drop was 42 percent.

Half-speed lines
Gartner Dataquest is predicting that the foundry industry's average capacity utilization will be in the range of 50 percent to 60 percent this year. That factors in a Christmastime boost. "This will drive a demand for semiconductors and components," said Ben Lee, principal semiconductor analyst at Dataquest in Taipei. "But that's under the assumption that the U.S. economy will perform better since Q4. If that does not happen, it will be a disaster."

Last year, the foundry industry grew by 72 percent to $12.9 billion, according to Dataquest. Capacity increased 43 percent. At Taiwan Semiconductor Manufacturing Co. (TSMC), capacity mushroomed by 72 percent from 1999 to 2000. Lee said he believes the foundries expanded too fast in the past three years, but acknowledged the breakneck growth was understandable amid the frenzy of growing demand, especially in the United States.

"If you check the American economy, you will notice it lasted through more than one decade of prosperity. That broke the entire economic cycle, especially for the high-tech sector. So people were too optimistic about the future of the high-tech sector, especially since 1998 and 1999 with the dot-com companies," he said. "This time, unfortunately, [the foundries] met a very serious correction for the semi industry. But I think it will be a short-term correction."

At TSMC, CEO Morris Chang thinks the industry has weathered the worst of the tech wreck. Not a week goes by in Taiwan where he isn't asked to predict the end of the foundry dog days. His answer is now a mantra: "The third quarter will be better than second and fourth better than the third."

Unlike UMC, TSMC's Chang is hanging more hope on the company's customer forecasts as well as its monthly ratio of orders to shipments, known as the book-to-bill ratio. "The book-to-bill ratio started to drop in the third quarter of last year and it dropped every month since then until April," he said. "In April, it went just barely above one and in May it was also just barely above one. That is the surest sign that we have touched bottom."

For a rise in the semiconductor cycle, Chang said the ratio would have to sail considerably above one. That hasn't happened yet. So he is using customers' forecasts, which so far have shown a predicted uptick in orders. "So I'm very hopeful that this will start to rise above one in the next few months. That's why I keep saying that the third quarter will be slightly better than the second quarter and the fourth quarter better than the third. It is more than hope. It's based on this index and customers' forecasts," Chang said.

The industry may be coasting at or close to the bottom, Gartner's Lee said. "But if you ask how long will this recession last, I don't think anybody can answer this question. It depends on how the American market performs. From my point of view, things don't look so bad."

Lee believes the overall American economy is showing signs of stabilization and noted that the inflation rate still looks under control. With the Federal Reserve continuing its interest rate cutting, Lee said the economy would eventually be stimulated. It's just a matter of when.

Capital-cost caution
Until that point, TSMC and UMC are being cautious about capital expenditures. Both companies have made dramatic reductions this year, as has Chartered Semiconductor Manufacturing Pte. Ltd. The Singapore-based foundry continues to be the hardest hit of the top three foundries, showing losses in the first and second quarters.

Because of second-half uncertainty, earlier promises to maintain the rate of 300-mm wafer fab development are proving hard to keep. TSMC has delayed the tool move-in at Fab 14, its first full-fledged 300-mm facility. And UMC is in a slow ramp of Fab 12, its first Taiwan-based 300-mm wafer fab.

This is putting a crimp in upstream equipment suppliers. North American-based manufacturers of semiconductor equipment posted $704 million in orders in May 2001, down 75 percent from the year before, according to Semiconductor Equipment and Materials International (SEMI). The book-to-bill ratio was 0.46, which means that $46 worth of new orders was received for every $100 of product shipped for the month, SEMI said.

The industry group expects a worse performance in the coming months. In a June statement, Stanley T. Myers, president and CEO of SEMI, said, "It is likely that the prospects for sustained year-over-year improvements in monthly shipments are three to four quarters away. On a worldwide basis, we currently anticipate a 30 to 32 percent annual decline in the semiconductor equipment market in 2001."

About the only bright spot in the downturn is the potential it has created for even more future business at the foundries. UMC's Chang said this year's gloom and doom is causing more IDMs to question the viability of owning fabs.

In the long term he sees the transition picking up speed, especially among second-tier IDMs. "This downturn helped them make the decision," he said. "Think about it. As the recession gets longer they are getting anxious. Compare them to fabless companies. The only problem fabless have is inventory. . . . They don't have to sit on millions and millions in depreciation costs at fabs. We're the ones that carry the bag for them. So it makes [IDMs] rethink their competitiveness. In this downturn situation they lose big."

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