Semiconductor Economies of Scale

This document is directed at investment professionals and qualified investors (as defined by MiFID/FCA regulations).

The global semiconductor industry, which represents over $450 billion of annual sales, operates very differently from most other areas of technology. We believe the semiconductor industry enjoys a concept we call “continuous economies of scale.” This means that the larger companies become, the more their protective barriers to entry strengthen and the more their margins rise.

Average Semiconductor Company Operating Margins

• Average semiconductor company operating margins have increased from 13.7% in 1Q06 to 16.2% in 3Q19.
• In semiconductors the slowing of Moore’s Law1 causes advances in speed or capability to require more engineering capital. This capital hurdle prevents venture capital-backed startups from creating cost-competitive products to compete against larger incumbents.
• The investment required to produce cutting-edge silicon, a primary ingredient in semiconductors, is additive. Years of capital expenditures—on equipment, buildings and chip architecture need to be aggregated to determine the total cost of replicating a product. We think the barriers to entry created by this capital intensity can last multiple decades.
• We believe the leaders in subsectors of semiconductors—especially in capital intensive areas like foundry—offer the potential for strong, long-term returns for tech investors. Additionally, we believe continuous economies of scale will continue to consolidate the semiconductor industry by removing subscale companies, increasing barriers to entry and improving pricing power, which should together reduce the industry’s cyclicality and improve long-term margins.