OREANDA-NEWS. Slowing smartphone and tablet demand growth and declining PC sales in the next 12 months are likely to drive further consolidation in the highly fragmented USD25bn integrated circuit (IC) outsourced semiconductor assembly and test (OSAT) industry, Fitch Ratings says. Consolidation could help smaller and weaker companies strengthen their capacity utilisation and market position in the face of falling revenue and profit. Taiwanese OSAT companies could also consider deals in response to growing competition from Chinese government-funded rivals.

We believe that OSAT industry revenue could fall by 10% during 2015-16 and EBITDA profits may drop by mid- to high-teens percentages due to slowing end-device demand growth, especially for smartphones as users replace them less frequently. OSAT companies are particularly exposed to changes in demand. This is because integrated device manufacturers and foundries that use OSAT services also have in-house facilities and they tend to disproportionately cut outsourcing during slowdowns.

Market leader Advanced Semiconductor Engineering Inc.'s (ASE) USD1bn cash acquisition of a 24.99% stake in third-largest OSAT peer, Siliconware Precision Industries Co. Ltd (SPIL), is unlikely to affect its 'BBB' rating with Stable Outlook. ASE wishes to use this acquisition to explore possible cooperation between ASE and SPIL. ASE's 2015 FFO-adjusted leverage could deteriorate closer to Fitch's negative rating guidance of 2.0x, but it should improve in 2016-17 given ASE's ability to generate positive free cash flow thanks to its market leadership and its advanced technological abilities.

SPIL and Hon Hai Precision Industry recently proposed a share swap to strengthen their product offerings, which are backed by SPIL's advanced packaging abilities and Hon Hai's system-in-package (SiP) technology. This transaction will be subject to SPIL shareholder approval at an EGM on 15 October 2015. Should the transaction proceed, Hon Hai will hold a 21.24% stake in SPIL and SPIL will own 2.2% of Hon Hai.

We believe that the Taiwanese OSAT companies' consolidation drive is a response to rising Chinese competition. Industry competition could intensify as the Chinese government-funded Integrated Circuit Industry Investment Fund (IC fund) is investing in each semiconductor industry segment and acquiring new technologies. China-based Jiangsu Changjiang Electronics' acquisition of STATS ChipPAC Limited for an equity value of USD780m will make it the fourth-largest operator with an 11% revenue market share. The deal will also provide advanced IC packaging capability, established relationships with US- and Europe-based customers, and exposure to growing Chinese demand.

Smaller OSAT competitors with less than 5% market share, including Powertech Technology, Global A&T Electronics (B-/Stable), ChipMOS Technologies and Chipbond are among the others that could seek M&A. OSAT companies typically lack pricing power due to the fragmented industry and have relatively low bargaining power due to customer concentration and low switching costs.

Previous semiconductor industry slowdowns have generally lasted 18-24 months before a demand bounce once excess inventory cleared and device sales picked up. However, a prolonged industry slowdown could seriously affect smaller OSAT companies as lower capacity utilisation could seriously affect their cash generation and leverage.