POWERFUL CONNECTIONS‍

As global demand for greater computing power escalates as we enter a new era of artificial intelligence and the Internet of Things, relatively few companies will possess the technology required to fuel this boom. In this paper we look at the evolution of the semiconductor industry, the structural growth investment opportunities it offers, and why we think one manufacturer in the sector is the most important company in the world you’ve probably never heard of.

 KEY POINTS

• The world is entering a new era in computer evolution in which artificial intelligence and the Internet of Things will become more mainstream

• As the technology required to support this growth trend becomes increasingly complex some manufacturers are achieving complete market dominance in their sector

• The semiconductor industry has expanded at around 8% per annum over 20 years but is now poised to hit a ‘brewing sandstorm’ of exponential growth

• Munro Partners will continue to seek opportunities among global companies profiting from the coming inflection in demand for high performance computing

In the 1960s transistor radios were at the cutting edge of microelectronics technology. Being smaller and more portable than the clunky wireless sets in every household lounge room, they revolutionised the way people consumed information and listened to music. But while the transistor radio is long obsolete, the technology that created it – then in its infancy – was destined to play a critical role in the exponential growth in computer power that has continued to this day. The discovery of semiconductors, the creation of the integrated circuit and the ability to fit more and more transistors onto a single semiconductor wafer are what made modern electronics possible.

 FROM 2,000 TO 54 BILLION‍

In 1965 the director of research and development at integrated circuit manufacturer Fairchild Semiconductor, Gordon Moore, made a bold prediction. Because circuit components were shrinking and their production becoming more cost efficient, he forecast that the number of transistors that could be built into a circuit would every double two years.

As his theory became reality over the following years it was gradually enshrined in the industry’s evolution as Moore’s Law. Computers became faster at exponentially growing rates as more and more transistors could be crammed onto a semiconductor wafer. In 1971 Intel’s first chip contained roughly 2,000 transistors, whereas the latest graphics processing units produced by US semiconductor company Nvidia contain a staggering 54 billion.

Behind all the big technology companies like Samsung or Apple are dozens of providers further down the supply chain. As global growth investors, we liken investing in these companies to the age-old analogy of ‘selling picks and shovels to miners’. In particular we see a strong and enduring case for investing in companies building the semiconductor wafers that power the vast and growing global tech sector. As the chart below shows, we anticipate double digit growth in wafer fabrication over the next five years and beyond.

FROM MAINFRAMES TO MICRONS‍

Four distinct growth phases of computing technology have played out since Moore’s early days at Fairchild Semiconductor. 1960s computers were huge, power-hungry mainframe devices of the sort made famous by organisations like NASA. The 1970s began the era of the personal computer as an affordable consumer item and the rise to prominence of brands like Atari, Commodore and Sinclair – and the more rather more enduring Apple. The third phase was the mobile computer era, enabling global connectivity across smart phones and multiple other handheld devices.

We’re now entering a fourth growth phase – a time of exciting possibilities and huge investment potential via artificial intelligence (AI) and machine learning technology, where gigantic volumes of Cloud based real time data are generated and manipulated from virtually unlimited connectivity, from traffic lights to fridges to Covid-19 test results – the so-called Internet of Things.

Not only does the miniaturisation of integrated circuit components and exponential speeding up of computer power enable such new technological possibilities as artificial intelligence, but it also lowers costs. Over the last 20 years, albeit through several cycles, the semiconductor industry has grown at about 8% per annum. And as costs continue to fall and the global appetite for high-performing computer power continues to grow, a brewing sandstorm of semiconductor demand is fast approaching.

‍RIDING THE STORM

Although the semiconductor industry has always been in a structural growth trend for the reasons outlined above, we think it’s now about to inflect in a more serious way. Semiconductor demand has been in linear growth for a long time, but a combination of the 5G technology that enables Cloud connectivity, the computing requirements of AI, and what is effectively a technology war between the US and China are starting to drive demand growth exponentially.

Just when global semiconductor demand is poised for exponential growth, the number of companies supplying the necessary technology is dwindling as it becomes increasingly difficult to extend Moore’s Law. The challenge lies not so much in transistor miniaturisation but rather in the process of semiconductor lithography: the technique of stencilling the design pattern on a silicon wafer that enables the billions of transistors to be configured.

The next generation of lithographic technology is called extreme ultraviolet lithography (EUV), which in simple terms uses light to transfer a pattern onto a silicon wafer, etching lines so tiny they’re measurable in tenths of microns.

 HIGH PERFORMANCE COMPUTING ENABLER: ASML

Dutch lithography equipment supplier ASML developed serious competitive advantage as earlier lithography techniques evolved, but so technologically complex is EUV that ASML is now in a monopoly position after its competitor shave gradually dropped out of the race.

ASML is now the only manufacturer of the photolithography machines that enable semiconductor design to meet the AI era’s computing power requirements, and therefore the only company with the technology to enable Moore’s Law to continue.

The EUV machine that ASML builds to enable this is huge, highly complex, and comes at a huge price – around €138 million, or more than the cost of two Boeing 737s. ASML supplies these machines at very high margins to technology companies like Samsung and Intel, enabling ever faster computing power and the continuation of Moore’s Law nearly 60 years after its inception.

THE MOST IMPORTANT COMPANY IN THE WORLD YOU’VE NEVER HEARD OF

Because ASML is a monopoly manufacturer in an industry facing exponential demand growth, we see massive opportunity for long-term investors, and why we regard ASML as the most important company in the world that no-one’s ever heard of.

By investing in ASML we see a clear path to a tripling of earnings over the next five years, and therefore expect its share price to reflect this over a similar period, as ongoing structural earnings growth drives structural share price growth.

Such is the ever growing sophistication of semiconductor technology and the high performing computer needs of our fast changing world, its likely that ASML’s earnings potential will continue to remain strong beyond the next 5 years. And while extending Moore's Law will get harder over time, what we are sure about is that ASML is probably the only company in the world likely to make the next scientific breakthrough in semiconductor lithography needed to keep it going in some form well into the future.

When this happens, other investment opportunities will continue to emerge as demand for ever more powerful computers continues to inflect and as the competitive environment weakens, as it did for ASML. This is why high performance computing is one of our key Areas of Interest and why all of us here at Munro Partners will stay focused on finding the global growth success stories that will emerge from this exciting sector in the years to come.

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