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Idle Hands in China's Chip Business

Semiconductor fabrication plants are much like jet liners -- they only make money when they are in use, and when they're sitting idle, they just cost it.

Idle fabs are what ate into Intel's top line, hurting its gross margins in the last two quarters due to underutilized plants.

So China's fabrication plants must be in a world of hurt right now, because they are running at just 43 percent capacity in the first quarter, according to a report from market research firm iSuppli. They were running at 92 percent just five years ago.

What happened? Too much supply and too much similarity. The Chinese government subsidized the manufacture of plants with the goal of improving the nation's economy. For a while, it worked.

Then came the economic implosion last year.

"Unfortunately for China, the plan collapsed as global sales dried up before demand generated from internal sources was able to grow to match demand generated from the rest of the world," Len Jelinek, director and chief analyst for semiconductor manufacturing at iSuppli, said in a statement. "Once viewed by China's government as a pillar of growth, semiconductor manufacturing has turned out to be a financial burden."

As a result, China has to restructure its whole semiconductor industry before it simply collapses, Jelinek added, since these plants cost money when idle.

According to iSupply, China's utilization will rise to a mere 54 percent by the fourth quarter of this year, and grow to about 84 and 85 percent in 2012 and 2013, respectively. However, there will likely be consolidation as poorer-performing companies fall on the wayside: Weak companies will not survive two years of negative cash flow.

Making matters worse is the fact that the region's factories generated massive oversupply. How great is the problem? You don't have to look far for answers.

A second iSuppli report estimates that if all of the Taiwanese DRAM suppliers idled all their fabs, which represents 25 percent of global DRAM megabit production, the market would still be oversupplied.

Another problem is these fabs are often way behind in technology, and they are all using the same manufacturing processes and technologies, so there's nothing to separate one from the others. AMD (NYSE: AMD) is claiming it already has customer interest in its Globalfoundries spin-off simply because its 45nm capacity is ahead of many other fabs.

The oversupply of memory is so great that DRAM prices now amount to only one-third of the cost to make the product, according to Nam Hyung Kim, director and chief analyst for memory ICs and storage at iSuppli and author of the report. So Taiwanese memory makers won't make a dime until their products increase in price by 200 percent, which will not happen in an oversupply situation.

iSuppli expects that combined DRAM and NAND revenue will rise by 3.6 percent in the second quarter of 2009 and surge by 21.9 percent and 17.5 percent in the third and fourth quarters of the year, respectively. That's simply not enough to spur growth.

Besides cutting capacity, which suppliers have already been doing, fabrication plants have few options other than waiting for a fundamental demand recovery, wrote Kim. A second round of production cuts will take place this year, but won't impact balance sheets until late this year or early next year.

The only memory maker doing well, for now, is Samsung, because Apple (NASDAQ: AAPL) has made massive purchases of memory, all of it from Samsung. Other than that, no one is making big buys.