Changing semiconductor industry brings investor opportunities

Chipless firms license intellectual property (IP) cores to those with the expertise and capacity to produce the silicon. IP cores are basically the software-based descriptions of an integrated circuit design. I view the emergence of IP as an extension of the history of disaggregation I have seen as the semiconductor industry has evolved.

The semiconductor industry has been transitioning from a vertically integrated structure, in which a single company would perform the entire semiconductor production process, to an industry where separate companies focus on different stages of the process. Specifically, companies have emerged that specialize in semiconductor manufacturing equipment, manufacturing, electronic design automation, design integration and now intellectual property.

This disaggregation in semiconductors is important for investors to understand, because with each separation comes significant value creation. I believe that semiconductor IP firms can be among the best investor plays in the semiconductor industry because of the expanding market opportunity for IP as well as the attractive business models with very high margins.

Let me offer some historical perspective.

Semiconductor equipment manufacturers, such as Applied Materials, were the first to separate from the vertically integrated industry.

Then we saw the rise of foundries and companies such as TSMC and UMC, which focused exclusively on manufacturing. This rise of foundries allowed semiconductor companies without fabs, like Altera and Xilinx, to focus on their core competency in design and marketing while still having access to world-class manufacturing.

Electronic design automation (EDA) companies such as Cadence and Synopsys separated themselves from the vertical structure to support the increasing challenges in design. Design services firms have also grown as semiconductor designs have become larger and more complex and design engineers have become more scarce. Design services companies essentially supplement a company's internal design team.

Semiconductor intellectual property suppliers are the most recent group to separate from the vertical structure.

MIPS Technologies, ARM Holdings, ARC Cores and Tensilica are among an increasing number of firms that focus exclusively on processor design. Rambus licenses IP to chip-to-chip communications. Firms such as inSilicon, Artisan and Aspec provide IP for communications connectivity and foundation level IP blocks.

The merchant IP market has been growing faster than the overall semiconductor market, driven by the trend toward system-on-a-chip. As chips have been growing larger and as they are incorporating more functions that had previously been performed by separate chips, it has become more challenging for a single company to build and maintain proprietary forms of all parts of the design. Especially as time-to-market pressures have increased, semiconductor firms are finding that they can accelerate the design process by incorporating IP blocks that they license from merchant suppliers.

The IP market grew 36 percent to $417 million in 1999 while the total semiconductor market grew about 16 percent to $149 billion. The leading IP suppliers were ARM, with 21 percent of the market share, and MIPS, with 18.5 percent.

The total IP market is probably much larger than these merchant market estimates because many semiconductor companies currently develop their own IP for internal uses. The merchant IP market is clearly expanding as merchant suppliers capture more designs from the proprietary alternatives. With the increasing complexity of designs and pressure to get products to market quickly, I believe that more companies will outsource their IP.