OSAT Consolidation Continues

Advanced Semiconductor Engineering (ASE) and Siliconware Precision Industries Ltd. (SPIL) are beginning the process of uniting the two companies, which are among the largest outsourced semiconductor assembly and testing contractors in the world.

For now, the companies will continue to operate separately, while their shares are traded under the ASX symbol on the New York Stock Exchange. ASE Industrial Holding serves as the parent company for ASE and SPIL. But the merger is almost certain to change the competitive landscape in the assembly, packaging and test markets.

All of these areas are tough markets. ASE posted net income of $670 million on 2017 revenue that was just slightly shy of $9.8 billion. While that may seem like a lot of money, compared with many segments in the technology world it’s a tight operating margin.

The ASE/SPIL deal is being very closely watched by Amkor Technology, JCET Group, and smaller contractors. OSATs are not just competing among themselves anymore. Increasingly, they are facing competition from TSMC, UMC and other foundries, which have pressed into chip packaging and testing services for several years now. There are also internal assembly and testing operations at some of the bigger semiconductor vendors, such as Intel, Samsung Electronics, and Texas Instruments, that take away certain business opportunities.

“There are a bunch of pressures in the OSAT business that will shape the industry in coming years,” says Risto Puhakka, president of VLSI Research. TSMC is competing in the high-end packaging business, with Apple as its big customer, and integrated device manufacturers are also competing in that field, he notes. (TSMC’s largest customer, not identified in its most recent 20-F filing, accounted for 22% of the foundry’s 2017 net revenue.)

There is more competition on the horizon, too. “The other pressure point that the OSATs feel is China,” says Puhakka. “There’s a substantial amount of packaging coming up in China, with the much lower cost, whether it’s through subsidies or something else. There is definitely pressure at the low end. It comes in the form of price pressure. Because the OSATs want to keep up the volume; their pricing is a much tougher environment. If you look at those two trends, you see people probably want to get bigger, they want to be operating in China, they want to be more competitive. The cycle in R&D is to get back that high-end business, and there are a number of things pushing in those directions. If you look at the OSAT business last year, there was growth, but nothing spectacular. Then, you look at the assembly equipment demand, which was spectacularly hot, which means a lot of equipment went to others—other than the traditional OSATs. It went mainly to China, to IDMs, to TSMC, Samsung.”

China’s OSAT industry is mostly made up of smaller firms, aside from Jiangsu Changjiang Electronics Technology (JCET), which owns STATS ChipPAC and other companies. JCET acquired STATS ChipPAC in 2015.

ASE and SPIL will be involved in integration initiatives in the near future, according to Puhakka. “The bigger question is, what will Amkor do? What will JCET do? The big players may want to buy from China. That’s not out of the question, but there would be some regulatory hurdles, I would imagine, to do that.”

The large OSATs today have geographically diverse operations throughout Asia. But China represents the largest growth opportunity.

“It is a market not to be ignored,” he says. “It just that you have the Chinese regulations, the requirement of joint ventures and technology transfers. It makes people very uneasy to do something like that. Those kinds of actions have limited how much business transfers to China. If you’re operating in China, you have ongoing IP protection issues. You’re constantly making decisions about what IP are you moving to China, what are you not. By default, people are basically saying, whatever you move to China, it becomes Chinese knowledge.”

Fig. 1: Pressures mount for OSATs. Source: CLSA

Bigger deals
Just as more limited opportunities and growing R&D investments fostered some mega-deals in the semiconductor business, similar forces are at work in the assembly, package and test world, which serves the semiconductor companies.

“It was certainly no surprise that ASE and SPIL came together, because of the increasingly challenging OSAT business environment and the major consolidation we’re seeing in our customer base,” says Hal Lasky, senior vice president of sales and marketing for JCET Group, who also serves as executive vice president and chief sales officer for STATS ChipPAC. “It’s kind of inevitable that we would see this at the OSAT level. Clearly, we’re a part of that as well, as we are now a part of the JCET Group. What does it mean for the competition? As a company, we embrace this change, and we see many opportunities arising due to this merger. There are many semiconductor companies, our customers, who see a combined market share of ASE and SPIL within their own TAM. I call it unhealthy, or maybe a little too high. We’ve had many chances to compete for market share where, without this merger, we wouldn’t have. I absolutely believe this merger enhances the competitive nature of the OSAT space. Maybe it gives us a higher bar to shoot at, which is not necessarily a bad thing for this very competitive OSAT industry.”

Lasky anticipates there will be more consolidation ahead, for the OSAT segment in particular, and the semiconductor industry in general.

“In the OSAT space, while I do expect us to follow the trend, we won’t see quite the pace. There is still a chance to see continued OSAT consolidation, but maybe not at the pace of our customer set. And the issue with OSATs is that the long tail of our industry—where the small players are not always of interest for M&A for the larger OSAT because the return you get versus the alternative of just competing for the business—when you look at that and the ROI and the deal around that, it doesn’t come out in favor of acquisition. Also, in the OSAT space, the technology gap between top-tier OSATs and the smaller OSATs continues to grow. That has an impact on the interest level in the larger OSATs to drive M&A with smaller ones.”

So rather than accelerating consolidation, consolidation among OSATs actually could slow down, he says. At the same time, TSMC will continue to compete with OSAT contractors in IC packaging services. “Their solutions in the wafer-level space—InFO and CoWoS—those are outstanding packaging solutions. They are targeted at key segments in our customer space, and they are staking out their portion of the application space. Within the overall application space, there is a very good fit for those products. They’re investing in the back end, and they’re doing it in a way that makes sense to their business. And it lets them optimize their overall business model. I see them continuing with that and continuing to stake out that position. While that’s certainly a challenge to the OSAT space, it’s not really a killer. But we need to adapt to that.”

Peaceful coexistence?
So can foundries and OSATS live and work together?

“There’s no question that the answer to that is yes,” Lasky says. “I believe very strongly that there’s plenty of opportunity. As we adapt to that shift in TAM, it’s mostly TSMC when you look at it, the bottom line is I believe very strongly in the spirit of co-opetition, because we continue to work very closely with the foundries to take care of and support our customers. Key to how we adapt as an OSAT industry really is finding where our strengths and our capabilities in the OSAT industry can take advantage of new growth areas, to take TAM back versus losing it to the foundries.”

The system-in-package module space is one area where OSATs can really shine, Lasky asserts.

“When these higher-level solutions involve multiple die, multiple devices, and you need to integrate at the packaging level to create a packaging-level solution, suddenly you need the abilities of OSATs, where in the past you might have done that as an EMS board-level solution,” he says. “There’s miniaturization, there are shielding concerns, there are a lot of different intricate process-level concerns, and it’s required at a very high yield. And those are all things that we play well in. We’re starting to see our TAM actually grow in that space in the OSAT world. There is no one packaging solution that’s going to wallpaper the entire application space. You need to find your strengths, find where your capabilities can let you grab share, and then go for that. Even in wafer-level, where the foundries have the very strong solutions for some of these processors, we have our own fan-out wafer-level and wafer-level CSP solutions that don’t make sense in the foundry space. The OSAT can do a better job.”

Ron Huemoeller, corporate vice president of Amkor and head of corporate R&D, likewise sees big changes and challenges in the OSAT industry.

“It’s a changing competitive environment and the OSAT market continues to narrow at the top, with only two OSATs remaining dominant in all phases of technology, ASE and Amkor, following the merger of SPIL and ASE. With fewer choices, more dependence on the premier OSATs is inevitable. It is important to note that developing and manufacturing new package platforms is expensive, and it requires a high degree of engineering expertise. It also requires perpetual funding in R&D to maintain competitiveness. Adding new blocks of capacity is very expensive – continually challenging ROI.”

Whether that will lead to more consolidation, and how quickly, remains to be seen.

“The OSAT business requires scale,” says Prasad Dhond, Amkor’s vice president and general manager of automotive. “There will continue to be some level of consolidation as players try to combine their resources to compete. This might now be more applicable to the smaller (Tier 2 and Tier 3) players, though. Foundries are making a push into certain segments of high-end packaging. They view this as an opportunity to cross-sell additional services and also to make their business stickier. However, from a fundamental business model standpoint, packaging margins are lower than what foundries are used to. It is not clear if foundries will be willing to make heavy CapEx investments in packaging when they could be using the capital for something else.”

So does that mean everyone will co-exist in their own space?

“One of the key aspects of foundry success in entering into the OSAT market segment is the bundling of their silicon with advanced packaging technology,” Huemoeller observes. “They secure the silicon sale by attaching it to the package technology. Foundries and OSATs are key components of the ecosystem. The foundries won’t engage in all aspects of the assembly and test business. There are niche areas they will play in, but there will always be a need for them to work with OSATs for other applications and if volumes exceed certain thresholds.”

Behind the ASE-SPIL deal
In its 20-F filing with the Securities and Exchange Commission for 2017, ASE provided an in-depth look at market pressures and developments in this space.

“We have significantly expanded our operations through both organic growth and acquisitions in recent years,” ASE says. “For example, we acquired the controlling interest of Universal Scientific in 2010 to expand our product offering scope to electronic manufacturing services; we also entered into a joint venture agreement with TDK Corporation in May 2015 to further expand our business in embedded substrates; in June 2016, we entered into the Joint Share Exchange Agreement with SPIL to take advantage of the synergy effect of business combination between SPIL and us; furthermore, we entered into a joint venture agreement with Qualcomm Incorporated in February 2018 to expand our SiP business. We expect that we will continue to expand our operations in the future. The purpose of our expansion is mainly to provide total solutions to existing customers or to attract new customers and broaden our product range for a variety of end-use applications. However, rapid expansion may place a strain on our managerial, technical, financial, operational and other resources. As a result of our expansion, we have implemented and will continue to implement additional operational and financial controls and hire and train additional personnel. Any failure to manage our growth effectively could lead to inefficiencies and redundancies and result in reduced growth prospects and profitability.”

It adds, “The successful consummation of the SPIL Acquisition is subject to a number of factors, including, among other things, obtaining all necessary antitrust or other regulatory approvals in Taiwan, the United States, the PRC and other jurisdictions where we do business. We received a no-objection letter in respect of the Share Exchange from the TFTC on November 16, 2016. On May 15, 2017, we received a letter from the FTC confirming that the non-public investigation on the Share Exchange has been closed. On November 24, 2017, we received approval from the Ministry of Commerce of the People’s Republic of China (MOFCOM) for the Share Exchange under the condition that ASE and SPIL maintain independent operations, among other conditions, for 24 months. In the event these conditions cannot be satisfied, we may re-evaluate our interest in SPIL and may consider, among other legally permissible alternatives, to dispose our SPIL shares at a loss, which may significantly affect our financial position. Notwithstanding the above, even if we are successful in consummating the SPIL Acquisition, we will be subject to regulatory restrictions requiring us to maintain separate operation of SPIL for a period of time, and we may face challenges in successfully integrating SPIL into our existing organization or in realizing anticipated benefits and cost synergies afterwards. Each of these risks could have a material adverse effect on our business and operations, including our relationship with customers, suppliers, employees and other constituencies, or otherwise adversely affect our financial condition and results of operations.”

The 20-F says, “The packaging and testing business is capital-intensive. We will need capital to fund the expansion of our facilities as well as fund our research and development activities in order to remain competitive. We believe that our existing cash, marketable securities, expected cash flow from operations and existing credit lines under our loan facilities will be sufficient to meet our capital expenditures, working capital, cash obligations under our existing debt and lease arrangements, and other requirements for at least the next twelve months. However, future capacity expansions or market or other developments may cause us to require additional funds…If we are unable to obtain funding in a timely manner or on acceptable terms, our results of operations and financial conditions may be materially and adversely affected.”

ASE has a co-opetition relationship with TSMC. The two companies have had a “strategic alliance” since 1997. ASE serves as the foundry’s non-exclusive, preferred provider of packaging and testing services for microchips fabricated by TSMC.

Conclusion
While OSATs will have one larger competitor to deal with in the near future, those companies look forward to the fray. TSMC’s muscling in on the high-end packaging business, especially when it comes to Apple’s custom application processors for the iPhone and the iPad, is a competitive challenge.

Yet OSATs retain expertise in the areas of SiP modules, molded interconnect substrates, substrate-like printed circuit boards, semiconductor embedded in substrate, and other emerging technologies. And while competition continues to ratchet up, there are always new opportunities around the edges for companies with the expertise and investment dollars to continue eking out a healthy living.

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