OREANDA-NEWS. The impact of slowing smartphones sales growth on the semiconductor industry will be felt hardest by back-end companies, and will add to the pressure for consolidation as Chinese competition grows, says Fitch Ratings. Revenue and profit in the segment could fall by double-digit percentages in 2016 due to lower capacity utilisation and the largely fixed-cost nature of the business. We expect larger companies to acquire smaller ones, which could weaken their credit profile if acquisitions are funded by debt.

Saturation in the global device market will pose serious challenges to all semiconductor industry participants - including integrated device manufacturers (IDMs), foundries and outsourced assembly and testing companies (OSAT). But OSAT companies, which focus on the back end of the manufacturing process, suffer disproportionately during downturns as IDMs and foundries bring more testing and packaging back in-house, significantly cutting outsourcing demand.

Fitch expect smartphone sales will grow only by a low-single-digit percentage in 2016 following 10% growth in 2015. We forecast personal computer and tablet sales to decline by 3%-5% and 5%, respectively. We expect this will lead to a fall of at least 10%-15% in OSAT companies' 2016 revenue. EBIT margins may shrink to 5%, which would be the lowest in five years, and we expect utilisation rates to dip below 70% (2015: 75%-80%).

Previous semiconductor industry slowdowns have generally lasted 18-24 months before excess inventory cleared and device sales picked up. However, a prolonged industry slowdown exacerbated by slowing smartphone sales growth and the absence of a new mass-appeal device could hit the liquidity of smaller OSAT companies.

Smaller companies could merge to survive as profits decline and they lack financial flexibility to spend on R&D and capex. OSAT companies lack pricing power due to a fragmented industry, high customer concentration and low switching costs. Industry prices, which typically decline by 3%-5% a year, could fall further on competition from Chinese companies backed by the USD20bn government-funded Integrated Circuit Industry Investment Fund (IC Fund).

Taiwanese OSAT companies are already pursuing consolidation. We placed market leader Advanced Semiconductor Engineering's 'BBB' rating on Negative Watch in December following its plan to acquire the third-largest operator Siliconware Precision Industries (SPIL). Taiwan's Fair Trade Commission suspended its review of ASE's acquisition of SPIL in March 2016. However, ASE is still keen to acquire the 75% of SPIL which it does not currently own for USD4bn. ASE's ratings could come under pressure if such an acquisition were to be debt-funded.

The fourth-largest OSAT company, STATS ChipPAC (BB-/Stable), has low ratings headroom - given its high debt and its relatively high exposure to advanced packaging for high-end smartphones. Its 2016 revenue could decline by 15%-20% with a negative EBIT margin. Its ratings are based on the consolidated credit profile of its 100% parent, Jiangsu Changjiang Electronics Technology (JCET).

This consolidated profile will benefit from a potential equity injection of USD400m by Chinese largest foundry - Semiconductor Manufacturing Investment Corp. - and conversion of IC Fund's USD140m shareholder loan into equity.

Smaller OSAT competitors with less than a 5% market share are among the others that could seek mergers. These include Powertech Technology, Global A&T Electronics (GATE), ChipMOS Technologies and Chipbond. Chinese Tsinghua Unigroup has announced plans to acquire 25% stake in ChipMOS for USD368m.

Fitch placed GATE's 'B-' rating on Negative Outlook in October 2016, as we expect its liquidity to worsen due to lower cash generation and high interest costs.