Introduction to Semiconductors

 An overview of the semiconductor industry.  Aims to understand:

• What are the moats in the industry?  
• When you are looking at a company, where does it sit in the ecosystem?
• Long term trends.  Trends in this industry take years of industry-wide cooperation and billions of dollars to play out.  Once you can see a trend start, you can pick tomorrow's winners.

Types of Chips

Memory Chips

Memory chips were a commodity subject to wild supply and demand swings. Now the industry has consolidated into 3 players: Samsung, SK Hynix (both Korean) and Micron.

Source: For the first time in Memory, have durable profits finally arrived?

China's YMTC recently entered the market, aiming for a 6-8% market share in 2022.  Their chips are state-of-the-art, but YMTC is on the US blacklist.

Despite its oligopoly structure, the memory industry is in a downturn (crash?) now due to falling demand from a post-covid hangover.  While Samsung is maintaining capex.  The memory industry is still irrational.

In the long run:

• The Koreans look like winners due to scale and predatory capex/pricing.
• Micron looks like a loser due to debt and lack of EUV.
• YMTC will operate in its own market, but will slowly fall behind from lack of EUV.

Logic Chips

Two main types:

• CPU's run general instructions to allow a computer to do anything.  They are designed by Intel/AMD (for computers), or ARM (originally for handphones - now also computers).
• GPUs are specialised chips to perform simple math calculations.  Used for graphics displays (eg: realistic games) and AI (matrix calculations).  The leading GPU designer is NVDIA - they have a moat from their CUDA interface being a standard, but its being challenged.

Logic Chips are built in Fabs, usually separate from the company that designed them.  The foundry industry has consolidated so that only three companies can build modern logic chips:

Source: Fabricated Knowledge Substack

Of the three leading-edge players:

• Samsung is fucked for high end logic chips.  They have a top down management culture unsuited to technology development and are serial liars.
• TSMC is the clear leader due to their partnership with Apple.  The risk for TSMC is a Chinese blockade/invasion of Taiwan - I give it a 30% chance before 2030.  Even without war, new foundries have to be built elsewhere, which has to be bad for the market in the long term.
• Intel has historically fabbed its own chips from when it was the leader in the 90's, but has now fallen behind both in chip design and foundry capability.  Intel has a bad capital structure and was bleeding to death.  They may have stopped the bleeding with their Feb dividend cut.

CPUs are currently in a downturn due to the covid-hangover, but not as bad as memory.  

GPUs (including ASICS for crypto mining) are in a downturn, but NVDIA's stock is in an AI bubble.

Analog

Analog chips are simple ones used to convert "real-world data" (eg: light/voice for camera/phone) into digital signals to processed by other chips.

Players are Texas Instruments (design and fabs), Analog Devices (design only) and Tower Semiconductor (fabs).  All these companies look interesting.  Haven't looked at their valuations or the industry cycle.

System on a Chip (SOCs)

Up until 10 years ago, we made computers faster by improving their CPUs: squeezing more transistors into a piece of silicon, and increasing the clock speed (time to process one instruction).

This stopped working, and we now combine CPU, GPU and memory onto a single chip.  The idea is to allow different parts of the chip to perform specialised tasks (eg: in your phone: a GPU for video processing, with a less powerful CPU for general processing).  It allows more tasks to be done faster with less processing and heat.  Apple's desktop M1 chip used this in 2020 to leap over previous generations in terms of performance.

Some consequences of this are:

• Expect the decline of Intel/AMD chip designs in desktop/server computing.  Intel/AMD's x86 or x64 chips use CISC (complex instruction sets) which are unsuitable for SOCs.  The only advantage of x86/x64 is that you can run legacy DOS/windows programs developed since the early 80's.  ARM chips (which are non-x86 or RISC) were not able to run them, but this has changed.  Apple now has an emulator to run intel-compiled programs.  Microsoft is developing an arm based server and tablet devices.  Expect Wintel to die.  Expect the majority of servers/desktops to move to ARM based processors, while x86/x64 chips become a specialised market for running legacy software.
• Big Tech (Apple, Google, Microsoft, Amazon) design their own in-house chips for their products/operations.  e.g.: Amazon's Nitro SOC runs the hypervisor (VM manager) in their AWS, freeing up resources for user operations.  Google's TPUs run AI calculations.  This vertical integration can be a way to extend their moats.  (...Or maybe over-optimisation just distracts them from their real business: Amazon, Google).
• Increasing importance of the "packaging" part of the chip production process (below).

Classifying Chips by Usage and Size

Another way to categorise chips is by size (nm).  When discussing chips, you need to place them by size and timeline to know what parts of the industry you are talking about. 

Roughly they can be broken down into:

• High End: For phones, PCs and Servers.  Produced in Taiwan, the US and South Korea.  Designed in the US.  Probably anything smaller than 28nm.
• Medium End:  Probably 28nm or above.  For automobiles, aerospace.  Produced in Malaysia, Thailand, Philippines, Singapore, plus the above countries.
• Low End: For the IOT.  To help your refrigerator keep track of your shopping list.  Produced in China.

This diagram shows it visually:

Source: S&P Global (2021): Analog chips - poised to become the next big threat to automakers?

There was a huge shortage of medium end chips for car manufacturers in 2021.  Foundries cannot easily add capacity for these older chips, which are sold so cheaply because their production facilities are fully depreciated. New production facilities require higher prices and long term agreements.

Node sizes for the 3 foundry businesses are not equivalent: Intel's 10nm is equivalent to TSMC's 7nm (so its now called "Intel 7"), and Intel's 7nm ("Intel 4") is equivalent to TSMC's 4nm.  See "Node Name Disconnect".

Production Process

The 5 steps of chip production.  Generally, the outputs of each step are the inputs to the next:

Wafers

Produce the silicon wafers that chips will be printed on.  The wafer market was an oligopoly, but may now be cracking:

• 5 companies produce(d?) 90% of silicon wafers (p5).  2 of those are Japanese: Sumco and Shin Etsu.
• 150mm and 200mm wafers are for older chips, 350mm are for newer ones.  A proposal for 450mm wafers was killed by TSMC in 2013.  The industry hasn't changed much since the 90's.
• Sumco expects no capacity expansion till 2024, despite a wafer shortage.
• This may give space for Chinese companies to enter the market, especially for 150 and 200mm.  Chinese firms expanded production in 2021.  South Korean imports form China almost doubled from 2020 to 2022.  Chinese wafers are reportedly 5-10x cheaper than Japanese ones.

Lithography (ASML)

Lithography is the process of etching circuits into a wafer.  A good description is in Doug O'Lauglin's Fabricated Knowledge.  Chips 7nm or below require EUV, which is from one company: ASML.

ASML's EUV machines are incredibly complex and precise:

• "molten tin droplets of around 25 microns in diameter are ejected from a generator at 70 meters per second. As they fall, the droplets are hit first by a low-intensity laser pulse that flattens them into a pancake shape. Then a more powerful laser pulse vaporizes the flattened droplet to create a plasma that emits EUV light. To produce enough light to manufacture microchips, this process is repeated 50,000 times every second."  
• ASML's supply chain is worldwide.  Their suppliers are small companies that each specialise in one out of the hundreds of steps required. (eg: A small company in Vienna selling equipment to produce photomasks).

No one can replicate this and integrate the work of hundreds of suppliers to the required precision.  Especially when the market is limited to three customers who all invested in ASML in the first place.  ASML is a monopoly for the next ten years.

If I was buying ASML, valuation is the only question and the key number is their recurring revenue for their installed base vs new sales.  The stock is too expensive now.  ASML or its suppliers may be a cyclical play later.

Applied Materials Sculpta process may halve the need for EUV.  Or maybe not.  Hard for lay people to judge.

Inspection

Covers non-intrusive ays to measure a chip to make sure its correct.  Theoretically it means using beams of electrons, x-rays or light to measure the surface of a chip.  The complexity is in interpreting information from the reflected beams to form a picture of reality.  More details from Fabricated Knowledge's Meterology Primer.

Packaging

Attaching the silicon chip onto a motherboard. From old to new:

• From the old days, a DIP chip package, with its iconic "spider legs":

• Wire bonding: Using copper wire to attach the chip to the circuit board.
• Flip Chip: Depositing an array of solder balls onto the board's pads, and "flipping" the chip onto it.

• 2.5D packaging: TSVs passing through the wafer (like underground cables) connect different chips on the board.  Used for SOCs.
• 3D packaging: Connect different chips which are all sitting on top of each other (on the circuit board).  Currently used in memory chips, not yet in logic chips.

See Fabricated Knowedge's Packaging Primer for more.

Testing

Theres two levels of testing:

• Functional Testing: Running a current through a chip to test input and output combinations.
• System Level Testing: Test the chips under the conditions they are expected to be used.  eg: Test at varying temperatures, or for long run-times (burn-in), structural tests, or software level testing (calling the chips functions/libraries in the same way that software wold).

The big companies involved in the last 3 steps are Applied Materials, Lam Research and KLA Tencor.  

2.5D or 3D packaging may be done more by the fabs (TSMC). 

Conclusions

Theres less than 10 big players forming the semiconductor ecosystem.

Things change slowly, but they do change.  eg: Wintel's fall and TSMC's rise.  These are not Buffet-like stocks to pass to your grandkids.

I believe China will not be able to make high end logic chips - they would have to replicate an entire ecosystem.  They can do high end memory.

Biggest moat is for ASML.  But everybody knows it and they are expensive.

TSMC is the clear foundry leader, and fabs have pricing power.  They are reasonably priced, though probably its not the right time in the cycle.  Big geo-political risk.

Intel was dying.  They have stopped the bleeding.  Maybe a turnaround play?  Can they get the money to build Fabs in a downturn, and as the market moves away from CISC?

Resources

• Fabricated Knowledge Substack.  Good introduction.
• Semi Analysis Substack: Goes into more details.
• SemiWiki: I can't understand their technical articles, but can read their business ones.
• Transistor radio podcasts.

My Positions

Not much changed.  My shorts are still slightly in the red while waiting for the big bear market.  Dunno weather it'll be a crash like March 2020 or continue to be a long one like 2001-02.

Update 23/Apr - the numbers were wrong, there was an extra minus sign making one of my shorts long. The real numbers in Mar were:

The only position changes have been:

• Bought gold in Feb.  As we move into the second half of the bear market and rate expectations drop, gold should do well.  Unless we get a crash like March 2020.
• Interactive Brokers forced me out of my short Italy (EWI) position at the worst time, I replaced it with XLB, BITO, XOP, INDA.
• Still regularly adding cash, the salary from my day-job as a garbage man.  Added around 3% cash this year.

The percentage changes:

• Oil dropped, and my oil/gas producers/pipelines with it.  Oil price is the biggest factor affecting my portfolio.  Wiped off around 4-5% of the portfolio.  My bet on oil rising due to Chiana reopening failed.  Still holding these positions.  Tempted to buy more Equinor now.  Or Tidewater.  Dunno....they'll drop if we get a crash, but could go up if its a long-drawn-out bear market.
• Delfi rose 30% on good results to become my largest position.  Not selling, its still cheap-and-growing, will buy a little more if the market crashes.

 Overall, still treading water.  Its a tough market, for longs or shorts.

My Shopping List

Long term I think we're in a decade of inflation.  After a 6-12 month downturn, commodities should continue their bull market.  I'm holding my opex commodity producers (energy, palm oil) and want to load up on capex commodity producers in the downturn.  I think the next bubble won't be the last (tech & crypto), it'll be commodities.

Short term I believe we are in for a market crash and a recession in the first half of this year. Don't know when.  After I cover my shorts, I need to buy.  Real money is made being long.  This is my watchlist.  Top of the list are dividend-paying blue chips that your grandfather would approve of, the bottom is the most speculative shit that can fly:

• Delfi (SGX): Largest Indonesian chocolate maker, net cash, paying out half its profits at just under a 4% yield.  Can be re-rated as a growth stock if it can grow for a few years.  Potential multibagger: 3 to 5X over 5-10 years.  I can only buy a little, since I've already loaded up.
• Singapore banks: Dividend paying cyclicals, too expensive now, wait for a recession.  No point doing a deep dive since they are all the same.  OCBC is the most conservative, DBS has the highest beta (with historically the highest write offs in a recession).  UOB has the least exposure to China.  Probably 30-40% upside in a cycle if I play it right.
• Maybank (KLSE): Another conservative, high dividend payer.  Low beta banking stock, ~6% (peakish) dividend at 80% payout ratio. Maybe 20% upside in a cycle.
• Boustead (SGX): A strange mix of businesses consisting of Asian ESRI software licensing, industrial real-estate and oilfield equipment providers.  Financially conservative: Net cash, pays out half its profits as dividends.  Could double in the next few years as oil E&P picks up, 5% yield at 50% payout ratio while you wait.  Asian Centure Stock's paid report.
• S&P 500: For my retirement account.  Won't do great with high energy prices and inflation, but there's some beta to be earned if I buy in a crash.  Sell when the recession's over.  Maybe 20-30% upside next cycle after a crash.
• Gold: goes up when real rates go down.  I am holding GLD now, into a recession/crash as interest rate expectations start to fall.  Want to hold Gold Miners (GDX or GDXJ) coming out of it, as interest rates fall and inflation expectations rise.  Lets see.
• Aluminium: Norsk Hydro.  One third of the aluminium price is from energy.  European smelters have been closing down.  Pays a giant dividend based on massive 2021 (peak) profits.  But its a capex commodity, so wait for the downturn.  Norsk Hydro is a low-cost producer, Alcoa is further out on the risk/reward curve.
• Rockwell Automation: As the US re-industrialises and wages stay high due to retiring boomers, we should see a secular increase in automation.  This stock is too expensive now, needs to halve to ~160 for me to catch falling knife.  Its cyclical - trades closely with the Nasdaq - so I might get a chance.
• Copper: Theres always been a story about an impending copper shortage for electrification/EVs.  I prefer to treat it as a cyclical.  Just buy COPX in a downturn.
• Largan Precision looks interesting.  Small bet due to their industry risks (biggest customer is wary of them), but it is reasonably priced.  50-70% upside now, more if the market crashes like I expect. (Asian Century Stock's paid report).
• Tin: A cross between a capex and opex commodity, half of it is used for electronics.  Again wait for the downturn.  MLX:ASX and MSC:KLSE could go up 3-5 times from the next cycle's bottom. 
• Lithium: Another capex metal.  If EV demand explodes, it may be a decade long bull market, like iron ore from 2001 to 2010.  Demand and supply are impossible to project, as they just exponential increasing curves.  Still too expensive now, wait for a pullback.
• Bitcoin.  The world's first decentralised digital currency.  Trades like a risk-on commodity, so wait for the downturn.  After which its probably got 2-3X upside in the next cycle.  
• MercadoLibre: South American Amazon, with a growth runway, may benefit from Sea Limited's decline.  Although its a real business, its a growth stock, so don't bother to value or model it.  Latam benefits from high commodity prices, and Mexico from NAFTA.  Its really just a high beta play - buy after a downturn, hopefully sell one or two years later when everyone's happy.  Make it a small bet so I don't get shaken out by high volatility.  3 or 4X upside in the next cycle.
• ChainLink: A cryptocurrency, I see it as a venture capital fund or company trying to establish a monopoly on all off-chain operations for defi....remember defi?  If defi takes off, its like buying Microsoft in 1995 or Amazon in 2001.  Just a small bet: theres plenty of ways this goes to zero.  20X upside.

Every paragraph above - except gold - says "buy in a downturn".

Its all the same trade.

Sold my last S-REIT

Sold my last holdings of Frasers Centerpoint Trust.  Small capital loss of less than 1K, offset by 12K dividends.

They announced they are buying a 25% stake in Serangoon Nex (85 years remaining lease), funded by debt.

Its not a bad deal, not like MapleTree Commercial Trust's disastrous merger a year ago.  But its not a great deal either.  Their pro-forma calculations show a negligible 0.5% increase in DPU if the transaction had been performed Oct 2021.  Leverageis expected to rise from 33% to 38.8% (Section 6.4).  

The negatives:

• Serangoon Nex is already crowded with 99.9% occupancy, so I don't see how they can extract more value from it.
• The company announced they are taking on a 410m revolving loan - they did not give the interest rate; revolving loans are usually variable.
• Increasing Leverage from 33 to 38.5% for a mere 0.5% increase in DPU doesn't make sense.
• Sibor has risen from 0.5% to 4% in the last year.  This has to affect Singapore property values, increasing FCT's leverage.  eg: A 10% decrease in property values would lead to Leverage increasing from 38.5% to 42%.  Now we are moving a bit close to MAS' 50% gearing limit.
• How are they going to make future acquisitions, like Northpoint South Wing?  They're gonna have to fund it entirely by issuing new shares.

The positives:

• Serangoon Nex is a good long-term asset.  Its a hub with 2 MRT lines and a bus interchange.  The mall is always crowded.
• On OCBC report stated (p2) that the new debt is taken at an "interest cost of less than 4.3% locked in for three years."  I think they are talking about the pro-forma calculations, which would mean these calculations already take into account high interest rates, and the results may be better if the Fed pivots soon.

Overall, the numbers just aren't great.  Buying a property yielding high 4's percentage points (gross), while taking on debt in the low 4's percent is barely a win.  Increasing leverage raises their risk and reduces their ability to bargain hunt when opportunities arise.  Since they are paying all their distributable income as dividends, they'll never decrease their debt and future growth is limited.  Their dividend yield is sub-5%.  I won't get rich holding a stock like this.

Need to find another way to get rich, holding SGX Reits won't cut it.  They have too much interest rate risk, and too little growth potential since they payout all profits as dividends.  I think theres better risk/reward in holding dividend companies that have fixed their debt 10-30 years out (eg: WMB, KMI), or cash rich companies that are paying out some of their profits as dividends (eg: Delfi:SGX or United Plantations:KLSE).

I still think we are in a multi-year inflationary bear market, and there will be a chance for me to buy more later.  I would rather own a company yielding 3-4% with a 50-60% payout ratio, than one paying out everything while yielding 5-6%.

I've now finished spring cleaning my portfolio.

The stocks that I have left are ones I'm comfortable holding through the cycle.

Gotten shorter

Got a lot shorter yesterday.  I think the market falls this quarter.  This is the max short I'm willing to go.

I moved a pile of cash into my IB account, so I have some leeway in case the market moves against me (ie: my longs go down and my shorts go up).  Risk Management means "try not to die".

Edit: Jan 13th: Went another 2% short, couldn't resist.

SEGRO REIT: exposure to rising interest rates

Quick look at a promising company, its a fast growing UK/EU industrial REIT whose share price is now tumbling.

For debt heavy REITS, one of the first things we look at is interest rate sensitivity.

As of end 2021, they had 3406m pounds of debt vs 15bn pounds of property.  Thats reasonable.

Their debt was well spread out:

Source: 2021 Full Year Results Presentation, slide 44.

And its all fixed rate too.  Looks really good:

Source: 2021 AR, p197

Wait, whats this?  After applying derivative instruments, they had a 1.5bn of variable rate debt:

Thats around 45% of their 3406bn debt being variable.  How can this be?

They have converted 1.9bn of their fixed rate debt to floating rate debt using derivatives....WTF?

~1bn of this only expires after 2026.  So they are not getting out of it anytime quickly.  ~600m expires from 2022 to 2026.

This is why their interest rate sensitivity is so high.  A decrease of 17m for a 1% increase in rates (p203) is about a 5% decrease in CFO.  If we expect UK risk free rates to rise to 4.5 to 5.25% by 2023, while they were under 0.5% in all of 2021, thats a 20-25% decrease in CFO.

I'm throwing this into the "too hard" basket.  Their debt has changed since then, and 2022 results will be out on 17th Feb.  But probably not worth looking at yet.  If I buy a REIT I want predictable cashflows, not a bet on interest rates.

Lessons Learned Trading Bear Markets

Trading bear markets is tough.  This post is about me finding a strategy to short bear markets, in a timeframe suitable for me.

My original plan was to simply short and hold into the depths of the bear market.

I had not counted on how sharp the bear market rallies would be:

Source: Wifey

I haven't covered my shorts, and I added to them last week.  But the last vicious bear market rally has given me some sleepless nights.  My shorts moved from a 70K profit to a 20K loss in 2 months!  I learned that prune juice helps constipation.

My timing wasn't great.  The chart below are my shorts (pink arrows) and coverings (blue arrows):

I can't trade day-to-day in the short term.  And its uncomfortable hodling shorts for the long term.  So I need to trade in the medium term - around the bear market rallies.  How can I do this when bear market rallies are unpredictable?

• Simply wait for the BMRs to occur, and as they do, add more.  Add a little at a 5% rally, more at 10%, more at 15% and some at 20%.
• If the BMR doesn't occur, don't short.  Take the attitude that I'll short if the market gives me the opportunity, but I don't have to.  I always have the choice to happily sit in my dividend stocks and cash, waiting for valuations to go low enough or for the macro outlook to change.  We get the worst results when we feel compelled to do something.
• Take some profits when it feels great.  When the market has dropped like a rock for several weeks, your profits are exploding night-by-night, and you are the king of the world...take some profit - maybe 1/3rd or half of my short positions.  I guess everyone learns this instinctively as they trade.
• Don't look at my percentage allocation (eg: shorts vs longs).  Successful short positions shrink, so at the bottom of a crash, they'll be small positions, just when I should be covering (making them even smaller).  Don't have a "target allocation".

We may be halfway through the bear market now.  As we get closer to its end, hodling shorts becomes a really bad idea.   I need to trade around the bear market rallies.  And start taking profits.  Wait for the next leg down...

With the last few days drop, my shorts are now profitable again.

Maybe this bear market rally ended last week:

Source: Keith McCollough