GlobalFoundries Starts 2024 With a Weak First Quarter Then Faces Aggressive Expansion by Peers

Equity Analyst

Phelix Lee

GlobalFoundries is vying for third place among contract semiconductor manufacturers, or foundries. It focuses on specialty products that perform narrower sets of tasks compared with the most advanced processors. These tasks range from storing small bits of data for very long periods to regulating electricity flows. GF has relinquished development of cutting-edge chips like smartphone and data center processors owing to financial, scale, and personnel constraints. Many of GF’s offerings are commoditized as they are fabricated on process technologies first debuted over a decade ago. Customers can obtain close substitutes at other chipmakers barring major shortages, which limits GF’s pricing power.

GF’s positioning puts it in a cohort of smaller foundries that choose not to offer cutting-edge chips. Its closest peers are United Microelectronics and SMIC. GF is increasingly focused on specialty products that cannot be manufactured elsewhere without significant customer redesigns, which helps boost its profitability. These products include radio frequency, automotive, embedded memory, and low-power chips. We think a higher contribution from specialty products and better factory utilization will allow the firm to expand its gross and operating margins in the coming years. Still, we forecast midcycle gross margin to be 5 percentage points short of management’s target of 40% due to pipeline capacity from multiple peers.

Foundries like GF need to balance between large capital expenditure budgets and saving enough for rainy days. The chip space is cyclical because of difficulties in matching new capacity, which takes three or four years to build, with incremental demand that is affected by structural growth and customers’ stocking practices. That said, we appreciate that GF has been using long-term agreements with customers to mitigate such cyclicality. We expect the company to incur $7.2 billion in total capital spending from 2024 to 2028 on expansions in Singapore, Europe, and the United States.

Business Strategy & Outlook

We believe that GF does not have a moat. GF’s most advanced manufacturing process, or node, is at least three nodes or six years behind leaders like TSMC, and Samsung Electronics . Given that GF is a technological laggard, we do not believe it has meaningful defenses to protect pricing from supply and demand shocks. Customers have no difficulty securing alternative supplies in most nodes that GF offers. GF turned its first annual GAAP profit in 2022, but we do not expect excess returns on invested capital consistently.

As foundries debut more advanced nodes, cost per area increases but transistor density rises even more, resulting in a net reduction in cost per performance. However, few companies can offer the latest process nodes because semiconductor manufacturing is capital-intensive and requires methodical planning and execution to keep chip costs at reasonable levels. Ballooning development costs for advanced nodes mean only the largest foundries can afford the scale required for a decent return, in turn justifying premium pricing that is the main source of excess returns. We think GF’s small market share (6% in 2023) means it has insufficient resources to uphold such an investment cycle.

GF’s smaller presence also limits the extent to which per-unit research and development costs can be spread. GF’s most advanced node is 12 nanometers, nine years behind TSMC. In contrast, global leaders like TSMC and Samsung provide 3 nm products and are expected to move on to 2 nm in 2025. Industry publications suggest leading foundries can deliver manufacturing advancements at least until 2040. As of the time of writing, UMC and GlobalFoundries have said they will not engage in R&D of sub-12 nm nodes owing to insufficient returns. Currently, most sub-12 nm products are used on smartphone-related applications, with Samsung and TSMC effectively splitting the subsegment.

We believe GF is unlikely to close the gap with global leaders even it wants to. In addition to high R&D costs required for advanced nodes, advanced plants are expensive to build. GF plans $700 million in capital expenditures in 2024, and its corresponding long-term target of 20% of sales should mean $2 billion capital spending in later years. But this is miles away from TSMC’s and Intel’s capital spending of tens of billions of dollars each year. Our base case assumes GF will continue to optimize 12 to 40 nm processes for its various applications like automotive and industrials.

Unlike leading foundries, GF does not enjoy special relationships with partners that can help build up know-how of advanced processes. For instance, TSMC, Samsung, and Intel invested in equipment vendor ASML to help the latter commercialize extreme ultraviolet lithography machines. These unique relationships help secure the latest equipment that comes with best performance, the lack of which puts GF at a disadvantage in terms of production yield and speed. Assuming GF has a business case for acquiring state-of-the-art equipment, customers have no reason to pay a premium to help it learn the ropes when they can get the same product elsewhere more reliably. 

GF’s average selling price is more than double that of other listed foundries save for TSMC. Higher ASPs are a major factor behind an economic moat but not sufficient in the case of GF. GF currently enjoys some advantage compared with SMIC and UMC as it has a larger contribution from the 12/14 nm node, but we think the edge is waning, as SMIC has helped Huawei produce chips advanced enough for smartphones, and UMC has announced a partnership with Intel to roll out 12 nm offerings by 2027.

Although GF’s focus on developing higher-value differentiated or specialty products at older nodes may lead to some growth and margin expansion, we view consistent excess ROICs as unlikely. We now view the returns during the pandemic-catalyzed chip shortage as unlikely to recur. New plants have been announced, and when they come online, we think the mature foundry market is unlikely to fall into a deep shortage. GF also does not have cutting-edge business, such as new processors for iPhones and data centers, which we view as more economically resilient. Specialty products typically run on older nodes that use fully depreciated equipment, which translates to lower manufacturing costs. A common example is selling automotive chips that must adhere to stricter requirements instead of a chip for a consumer Internet of Things device. Specialty products tend to innovate more slowly than their microprocessor cousins, but they still face obsolescence risks, and these risks have been heightening in recent years. For instance, TSMC’s new sites in Japan and Germany offer new 7 to 28 nm capacity to service automotive and industrial customers that threatens 12 to 65 nm alternatives by GF. 

Profitability has been lackluster for GF. The company had accumulated losses of over $15 billion leading up to its initial public offering in October 2021. GF’s gross and operating margins have fared the worst compared with foundry peers both before and after going public. While GF’s financials have improved since listing, its cash margin—measured by adding back depreciation and amortization to gross profit—remains at the bottom. GF pitches itself as the only major pure-play foundry that has no production in China and Taiwan, but TSMC’s, Samsung’s, and Intel’s expansions are blunting the appeal of its proposition. By expanding in the U.S., Europe, and Japan, other major foundries will level the playing field by addressing customers’ needs for supply chain resiliency.

None

Economic Moat

GlobalFoundries

GLOBALFOUNDRIES, Inc. provides foundry services and manufactures semiconductors. It offers global shuttle, mask, post-fab and turnkey services. The company was founded in 2009 and is headquartered in Malta, NY.

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GFS Q1 2023 Earnings: Challenges in Semiconductor Demand, Opportunities in Automotive

GFS faces challenges in semiconductor inventories and demand rebalancing but sees healthy demand in specific segments. The company's performance in the first quarter showed declines in revenue and adjusted gross margin. However, GFS added significant long-term agreements and aims to be free cash flow positive for the year, positioning itself for future growth.

GlobalFoundries meets Q2 revenue guidance, eyes growth in automotive and aerospace

GlobalFoundries reported strong Q2 2023 performance, meeting high-end guidance and highlighting healthy demand in automotive, industrial IoT, and aerospace and defense. The company's strategic partnerships and collaborations, along with its focus on diverse geographic manufacturing capacity, position it well for future growth. However, challenges in consumer-centric markets and complexities in inventory management were noted, emphasizing the need for a balanced approach during the current cycle.

GFS reports strong Q3 revenue, emphasizes automotive industry advantage

GFS reported strong Q3 revenue, with notable performance in automotive, IoT, and aerospace and defense end markets. The company expressed confidence in their shipments for Q4 and emphasized their advantage in the automotive industry. However, challenges exist in managing semiconductor inventory and addressing elevated inventory levels in certain end markets.

GlobalFoundries surpasses Q4 revenue targets, eyes growth amid challenges

GlobalFoundries (GFS) navigated challenges in 2023, exceeding revenue guidance and focusing on strategic partnerships. Caution for 2024 outlook due to market dynamics, but confidence in increased free cash flow delivery. Emphasis on differentiation, stable pricing, and capacity expansion positions GF for growth and resilience.

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GLOBALFOUNDRIES, Inc. provides foundry services and manufactures semiconductors. It offers global shuttle, mask, post-fab and turnkey services. The company was founded on October 7, 2008 and is headquartered in Malta, NY.

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Ford Motor Company (NYSE: F) and semiconductor manufacturer GlobalFoundries Inc. (NASDAQ: GFS) have entered into a partnership designed to boost chip supplies for Ford and the U.S. automotive industry. What Happened: The new partnership involves a non-binding agreement that enables GlobalFoundries to expand the semiconductor supply for Ford's current vehicle lineup while joining with the automaker in joint research and development to address the need for an increased chips volume to meet the automotive industry's needs, including semiconductor solutions for ADAS, battery management systems and in-vehicle networking.

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Ford Motor Co and chip manufacturer GlobalFoundries Inc on Thursday said they plan to work together to boost supplies for the automaker's vehicles and the broader U.S. auto industry but gave few details about what the deal entails.

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The companies on Thursday announced the signing of a nonbinding agreement for a strategic partnership that aims to increase the supply of chips to Ford.

Ford partners with GlobalFoundries to increase chip supplies

Agreement aims to build and strengthen a collaborative model to accelerate the next wave of innovation in automotive chip design

GlobalFoundries, Ford to Address Auto Chip Supply and Meet Growing Demand

The Pentagon plans to place up to $2 billion in rush orders by early March for customized semiconductors used in weapons like the B-2 bomber before the shut down of production line, Bloomberg reports. Globalfoundries Inc (NASDAQ: GFS) sold the factory in Fishkill, New York, that produced the specialized chips used in GPS-dependent systems to ON Semiconductor Corp (NASDAQ: ON).

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MALTA, N.Y., Nov. 02, 2021 (GLOBE NEWSWIRE) -- GlobalFoundries (NASDAQ: GFS) today announced that it will host a conference call on Tuesday, November 30, 2021, at 4:30pm U.S. Eastern Standard Time (EST) following the release of its third quarter of fiscal year 2021 financial results after market close.

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MALTA, N.Y., Nov. 1, 2021 /PRNewswire/ -- GlobalFoundries® (Nasdaq: GFS) (GF®), a global leader in feature-rich semiconductor manufacturing, today announced the closing of its initial public offering of 55,000,000 ordinary shares, 30,250,000 of which were offered by GF and 24,750,000 of which were offered by GF's existing shareholder, Mubadala Investment Company PJSC, at an initial public offering price of $47.00 per share.

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