Should you bet your (micro)chips on AI?

Tancredi Cordero, CEO of Kuros Associates, 22/06/2021

The global microchip shortage continues to have major real-world consequences. Recent research by global consulting firm, AlixPartners suggests that the shortage will cost global automakers $110bn alone. It is clear now that no-one can hide from this shortage, from automotive to home appliances, to railroads and up to space travel, technology is in behind everything that we do. It dominates day to day life, and investors can no longer look past this. 

The top producers have been very keen to highlight the funds they are piling in to dramatically increase their outputs. TSMC, the Taiwanese incumbent in the sector, recently announced plans to invest $30bn in 2021 alone to ensure they can continue to meet demand, while United Microelectronics Corporation (UMC) expects to invest as much as $1.5bn (up 50% from 2020). We’re also seeing some initial waves of consolidation, with Renesas Electronics allegedly in talks to buy the European chipmaker Dialog Semiconductor for a potential $6bn. In the longer term, supply will meet demand. 

However, across the short and mid-term you’ll likely need a crystal ball. The shortages are here to stay for at least another year, causing manufacturing to grind to a halt just at the key point when the global economy reopens. Ford and GM have pulled around 600,00 vehicles from production in the alone, with Ford suggesting it will cut Q2 earnings by about a half and could continue to impact production output throughout 2021 and into early 2022.

What does this mean for investors though, what position can you take at this crossroads? Has the shortage already highlighted the sector’s longer-term importance and value, to the same extent its subsequent surging demand and prices has led to short-term gains? Shares in chip producers have risen by XX% over the past year, double the equivalent return from global stocks. This has led to many suggesting that these microchip producers are overvalued, but as with everything that depends on how you are valuing them. 

For some time, investors have looked to microchips as a commodity – essentially the oil of the 21st century. This mentality has brought with it the volatility you would expect in terms of pricing. I beg to differ. Instead, I see it as infrastructure, or even an industrial enabler. Microchips facilitate the generation, analysis, and monetisation of data, much like pipelines did for oil. One should invest in microchips if you believe that a structural and longer-term increase in demand will occur, rather than just a mere inflationary spike in prices. Just like you shouldn’t invest in pipelines because you think that oil will go up in price, but because you think that growing demographics will drive up the demand.

But how do we get there? Where is this structural and longer-term increase in demand coming from that will validate the microchip holdings in my portfolio? The explosion of Artificial Intelligence (“AI”). 

Soon, every industry will need AI to compete. From self-driving cars able to map and predict roads infographics, to cloud based cybersecurity software and DNA mapping laboratories, everyone will need to implement it into their business processes. What does all of this have in common? Masses and masses of data. This data cannot be processed without microchips, which in essence become the enablers of the AI revolution. There is no AI without microchips, just like there is no pipeline without oil. Demand will continue to rise; the big players’ CAPEX and consolidation now is laying the groundworks to reap the benefits.

Look at it through this lens, and there is considerable scope for valuations to continue to climb. Take the ten biggest companies in the world by market valuation, nine are computer software and hardware focused businesses. All voracious microchip users. Today’s biggest chipmakers Taiwan Semicon and Nvidia rank 11th and 20th respectively. My prediction? Expect many more chipmakers to be taking their rightful, and higher, place across the top twenty within the next 15 years. Watch this space.

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