For years, the semiconductor industry has been under threat of consolidation as companies try to build enough scale to let them fund successive generations of high-integration devices. But the consolidation has failed to happen, much to the bemusement of analysts and other observers. It remains a process that is about to happen.
Wolfgang Ziebart, president of German chipmaker Infineon Technologies, pointed out at the recent Electronica trade show that the process is not likely to be a repeat of what happened in industries such as aluminium and steel. Instead specialists will form that dominate niches but are barely heard of outside their chosen markets. Weaker players will retreat from niches that they cannot control or influence rather than face price wars at the bottom of the market.
One of the vaunted reasons for massive consolidation to happen was the rising cost of building semiconductor fabs. People used to think $2bn was a lot - now $6bn is what you need to build an efficient, next-generation plant. Very few companies have the kind of business that can support that kind of investment. You need at least $2bn in annual sales just to think about it. And even then it would not be a wise investment. Because you have to fill it and keep it full to make any money at all.
Chipmaking is extremely sensitive to fab utilisation. Anything below 85 per cent full, three shifts a day, seven days a week, and you might as well heat it by burning dollar bills. But, that doesn't matter anymore to most chipmakers. They don't, for the most part, actually own the most advanced fabs.
Specialist foundry operators have built up the capital needed to keep much of the semiconductor industry on its roadmap to satisfy Moore's Law. By going fabless, suddenly it's someone else's problem to keep a fab full.
"Consolidation happened through the fabless model," said Wim Roelandts, president of Xilinx and one of the first companies to exploit the fabless model. "Without that there would have been a consolidation."
However, going fabless does not mean scale is no longer an issue. A startup can potentially break into a competitive business because it only has to fund the design and marketing of a single chip. However, chip design is getting more costly to finance. It used to be measured in hundreds of thousands of dollars. Now, you are unlikely to see much change from $20m for any significantly different design, and the number keeps going up. To play in the bigger markets, you need to spend a lot more. This is forcing a rethink at even bigger chipmakers.
There is a catalyst for change that was not present until 2006. The arrival of serious amounts of private-equity money in the semiconductor business - $28bn has gone on just two companies, Freescale Semiconductor and NXP Semiconductor - has clearly focused minds. Potentially any operation with an apparent opportunity for carve-outs or sell-on is now vulnerable to one of the most buoyant private-equity markets for years.
No-one wants to admit that private equity has convinced them to face hard truths, but with the investigation of so many companies behind the scenes by financiers, it's hard to see what other factors could have been such efficient catalysts for change. Decisions that were unthinkable before, largely for reasons of corporate hubris, have suddenly become easy to make - better to make the changes yourself as a board of directors rather than have someone come along and tell you what to do.
But, there is a bigger trend that lies behind the decision by companies to either strip out businesses they no longer want - as with International Rectifier's recent move to sell its power transistor operation to Vishay - or to join with other similarly sized players to seek market-share gains.
The decision of LSI Logic and Agere to combine operations in a 52/48 per cent deal is not just two former custom chipmakers huddling for protection but reflects a bigger change in the current environment for chipmakers.
Some claim that private equity is interested in the semiconductor business because "the cycles are over". Only the most deluded executives can think this is the case. As Roelandts pointed out, the time-scales in chipmaking are so different to those in the consumer markets that now dominate the spending on semiconductor components, cycles are inevitable. It's a cyclical business, always has been and seems likely to be so for the forseeable future.
No, the real reason is that companies have found that they have the choice to concentrate on only a few markets rather than try to build scale from whatever markets they found themselves to be in just so they can fill their fabs up.
CEOs of several of the major chipmakers pointed out in a panel session at Electronica that they have to be at the top of the list of suppliers in each market they serve, or expect to lose the money they spend on R&D to stay in that market. The message is: if you're not number three at least, get the hell out of that business.
However, former integrated device manufacturers (IDMs) are not quite ready to specialise in just one market. For the new LSI Logic, that would be a simple choice: storage electronics. Top disk-drive maker Seagate is Agere's number-one customer, accounting for a whopping quarter of the chipmaker's sales. At LSI right now, Seagate is hovering around the 10 per cent mark. Combined, the company will have close to $1.3bn in sales of chips to the storage sector alone: more than a third of the company's total revenues, with almost half of the purchases coming from Seagate. The drive maker is likely to end up with around a 17 per cent contribution to the greater LSI's sales.
Although the company has weaker positions in consumer electronics and Agere's other specialism, communications, the stated intent is to use the larger operation to try to build scale in those markets, while the older broad-based custom-chip operations are left to slowly wither away. Other parts may be sold off once an integration team has worked out how the two companies will really fit together. Talwalkar has not ruled out selling chunks of the new company off, although most of it was accounted for in a presentation to analysts made shortly after the announcement of the merger went out on the wires.
The handset baseband business is one of that could ultimately face a sell-off, although it fits into the consumer category that LSI wants to push. As cellphones mutate into personal entertainment products, it's not a bad fit. And Agere president and CEO Rick Clemmer was keen to stress its position in Samsung, providing two-thirds of the Korean giant's 2.5G baseband needs. However, baseband selection is not an area where handset makers expect to spend a lot of time in the future, making it easier for companies who can sell applications processors alongside basebands. It's not clear what LSI will have to offer in terms of applications engines for phones, other than experience in media decoders from its days as a settop-box chip supplier: companies such as Texas Instruments, Qualcomm and Freescale look to be better positioned.
The networking business of Agere is likely to stay. It forms one of the three legs of LSI's strategy for the combined operation alongside storage and consumer products. As a former arm of AT&T and Lucent, communications infrastructure runs through Agere like the writing in a stick of rock and the company continues to have significant business in this area, although it was badly hit by the recession of 2001.
As president and CEO of LSI, former Intel executive Talwalkar has demonstrated that he is prepared to make major changes to a company. He reversed the decision to spin out the storage systems business of LSI shortly after taking over. Earlier this year, he decided that it was time to sell the company's flagship chip-production plant and not just go fab-light, as Agere has done, but fabless. And he killed off the short-lived but expensive-to-develop RapidChip custom-IC project. It's easy to see Talwalkar, in charge of a larger LSI, deciding to sell the bits that no longer fit. It's the kind of approach that is likely to become fashionable as the top-50 players work out where their true businesses really lie.