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COMMENTS

Coronavirus A Wide-Ranging Ill For Tech Supply Chain


Coronavirus A Wide-Ranging Ill For Tech Supply Chain

The technology sector was consumed by the U.S.-China trade war over the past two years. The signing of the Phase One trade agreement on Jan. 15, 2020, between the two largest economies in the world certainly provided a sigh of relief. We forecast in November 2019 that smartphone, server, and semiconductor markets would return to growth in 2020 following a year of disappointing sales.

However, that now hangs in the balance as the unexpected and rapidly spreading coronavirus outbreak that originated in Wuhan, in China's Hubei province, became an international health concern in January 2020, threatening to paralyze the world's most important technology manufacturing hub.

China has led manufacturing of electronics for decades because of low-cost and skilled labor. The tech supply chain is optimized by strategically clustering manufacturing facilities such that delivery time from parts suppliers to manufacturing facilities is minimized and production flexibility (i.e., changed orders) meets customers' demand. This is important as hundreds of parts go into the production of smartphones, servers, notebooks, etc., from different parts of the world. While tech companies benefit from the low cost and time-to-market efficiencies of this complex setup, its drawbacks are magnified by exogenous shocks such as the coronavirus outbreak.

Chart 1

image

Since Jan. 23, 2020, Chinese state and local governments, in an attempt to control the spread of the virus, shut down Wuhan and many other Chinese cities under quarantine orders, affecting over 60 million people. Public transportation, trucks, couriers, rail, ships, and flights were halted. Manufacturing facilities remained closed beyond the Lunar New Year holidays.

Some companies were expected to resume manufacturing operations beginning Feb. 10--including Hon Hai Precision Industry Co. Ltd., Apple Inc.'s major iPhone and iPad supplier. Nevertheless, resumption of production is expected to be slow as it's unclear how many factory workers who live in cities miles from the factories can and will return to work given limited travel options and the continuing threat of the contagious coronavirus. Even if manufacturing facilities resume production, it's unclear when shipments can be flown to customers.

S&P Global Ratings' economics and research team currently estimate that the virus could lower China's GDP growth by 70 basis points (bps), to 5% this year, with a peak effect in the first quarter before a rebound begins in the third quarter, and lost output largely recovered by end of 2021. In turn, it would trim 30 bps from global GDP growth this year. Our baseline assumption is that the coronavirus crisis will stabilize globally in March 2020, with virtually no new transmissions in April (see "Coronavirus Casts Shadow Over Credit Outlook," Feb. 11, 2020). However, if the disease is not brought under control in March, the economic impact could be much larger. At this point, we haven't taken any rating actions on tech companies related to the coronavirus outbreak. We assume the impact to the global tech sector will be temporary and that near-term activity losses can be made up later.

For most tech products that don't exclusively rely on China for manufacturing and assembly, we expect tech companies to increase production activities elsewhere to make up for lost volume in China, or to identify alternate suppliers for key parts. While suboptimal, it is a quick remedy for a temporary disruption. More important, we expect most tech companies to be resilient and resourceful, seeking alternative suppliers and minimizing production disruptions and associated economic impact, much as they did when faced with potentially higher costs from tariffs and the ban on sale to Huawei Technologies Co. Ltd. over the past two years.

While some tech companies' business results and financial metrics may temporarily weaken from the supply chain disruption, we expect limited rating pressure as of now. So far, companies have maintained a cautious tone during earnings calls with wider revenue guidance for the subsequent quarter given the lack of clarity on the length and magnitude of the current disruption. For now, we largely expect reduced demand or supply chain disruption to reverse over time and limited rating pressure. If the outbreak is quickly contained, we do not see a risk of major disruption to the tech supply chain. We would expect affected tech companies to speed up production in the second half of 2020 to recoup lost revenues as enterprises and consumers catch up on delayed spending. We estimate that China accounts for more than 20% of global IT consumption.

Most tech companies we rate have stable rating outlooks, and their credit profiles also have cushion to tolerate a moderate decline in sales volumes. However, smaller companies with high geographical or product concentration in China would be more vulnerable even to short-term demand or supply disruptions if cash flow is impaired, given their generally weaker liquidity positions. In our view, higher credit risk would come from prolonged supply chain disruptions, which could lead to significant demand reductions, significant cash flow impact, or liquidity concerns.

How Coronavirus Will Affect Asia-Pacific

A temporary disruption in China's hardware supply chain is inevitable for the virus outbreak, even though most companies were to resume operations in most parts of China during the Feb. 10 week after the extended Lunar New Year break. Transportation restrictions and heightened quarantine measures countrywide could post challenges securing sufficient labor and material supply for hardware companies and limit production initially, although the epicenter of the outbreak, Hubei is not a major production hub. The impact of the epidemic on hardware companies in Asia varies, which depends on their exposure to the hardware supply chain and end markets in China, as well as their labor intensity.

EMS and electronics component companies such as Hon Hai are most exposed to labor and logistics challenges during the outbreak. It depends on external component and material supply for enormous facilities that employ hundreds of thousands of assembly line workers. Some of Hon Hai's facilities received approvals to restart on Feb. 10, but we believe it is unlikely to resume full production over the next 2-3 weeks at the earliest. It remains unclear how soon the company can return to normal operations, given the shortage in labor and protection gear.

Disruption for some Chinese tech companies, particularly in the semiconductor sector, could be less. Semiconductor Manufacturing International Corp. and fabrication plants for Taiwan Semiconductor Manufacturing Co. Ltd. (TSMC), Samsung Electronics Co. Ltd., and SK Hynix Inc. all report no disruption so far. However, bottlenecks throughout the supply chain will inevitably affect near-term shipments and revenue, in our view.

The first half of the year is typically the low season of the production cycle for most information technology devices, and this could partly alleviate underutilization for a brief time. The China government is also likely to actively assist key industries, including the tech sector, in maintaining normal operations and minimizing economic impact. Hon Hai as China's largest exporter is likely to benefit. In addition, we believe the short-term revenue and cash flow shortfall are unlikely to significantly diminish the leverage and liquidity buffer for the ratings on Hon Hai and Chinese hardware companies under our baseline assumptions.

Generally lower dependence on production facilities in China could help rated Korean and Japanese tech companies better manage production during the outbreak, in our view. Those companies have built significant capacity particularly in Southeast Asia to diversify their production footprints over the past few years. Nonetheless, revenue for Sharp Corp., TDK Corp., and SK Hynix could still drop significantly with a prolonged disruption because they generate more than 30% of their revenues from China. TSMC, Samsung, and Renesas Electronics Corp. could also lose revenues moderately, with more than 10% generated from China. Those companies mainly supply many key components including semiconductors, display panels, and batteries for final assembly in China.

We believe rating pressures on these companies are largely limited because the potential revenue and cash flow shortfall is unlikely to materially alter their financial positions based on current cash flow and leverage buffers. Nonetheless, ratings on weaker companies with low rating headroom, such as Sharp, could be more pressured if the outbreak persists longer than we expect and lead to a sustained decline in cash flow. Sharp's ratio of debt to EBITDA could deteriorate to above 5.5x, the level to sustain the current ratings, if revenue declines 10% annually.

How Coronavirus Will Affect North America

Tech original equipment manufacturers (OEMs), electronic manufacturing service (EMS) providers/contract manufacturers, parts and subassembly makers, and semiconductor firms will feel the impact of the coronavirus outbreak to varying degrees. We discuss here how each segment could be affected and our view on potential rating impact:

Smartphones

Apple, relative to other hardware OEMs, has been reluctant to diversify its manufacturing and assembly base away from China. We believe it wants closer ties to the world's most populous nation for product sales (China, Taiwan, and Hong Kong represent about 20% of Apple's total revenue) and to reap the benefit of a manufacturing cluster that allows better economics and flexibility in design changes.

To be sure, this strategic positioning comes with risk of supply chain being overly reliant on China. Now, Apple and its contract manufacturers have to contend with factory closures, or underutilizations if reopened, as certain local governments continue to uphold their quarantine orders. Migrant workers might not be able or willing to return to the factory floors. Transportation and logistics are also disrupted as routes for couriers, trucks, rail, ships, and flights might not return to normal for an extended period.

So far, Apple on its earnings call on Jan. 23 widened its revenue guidance to reflect the uncertainty around the coronavirus impact. Apple and its largest supplier, Hon Hai, said production would resume after a 10-day delay on Feb. 10. Apple also announced that most of its retail stores in China would be closed through Feb. 15 out of caution. While iPhone demand would temporarily slow, we believe customers are generally more loyal to Apple than other Chinese OEMs and expect demand will recover in subsequent months. On the supply side, we believe iPhone retail and factory inventory should be sufficient to alleviate short term production delays. Even if quarantine orders are lifted, we suspect it will take time for foot traffic to return. While Apple's track record of navigating supply chain challenges leads us to believe the coronavirus will not permanently impair its business, we expect underutilization of facilities and disruption of parts and components shipments to assembly plants would temporarily lower sales that would be recaptured over time.

We would not be surprised if this leads to near-term order cuts, which would have a cascading effect to its supply chain downstream (contract manufacturers and parts and components suppliers). However, we do not expect this will affect Apple's major product release this fall. Over the longer term, having suffered through the trade spat and now coronavirus, we suspect that Apple will seek to gradually diversify its manufacturing base away from China even at the risk of reducing profitability.

Table 1

Apple Inc. In China
Rating/Outlook Revenue Exposure To China China Property, Plants, and Equipment China Manufacturing Exposure Latest Public Disclosure
AA+/Stable 17% 24% Relies heavily on Hon Hai Precision Industry Co. Ltd. and other China-based contract manufacturers for production of the iPhone, iPad, and iMac. From Jan. 28, 2020, earnings call: "We expect revenue to be between $63 billion and $67 billion. The wider-than-usual revenue range comprehends uncertainty related to the recently unfolding public health situation in China. ... With respect to the supply chain, we do have some suppliers in the Wuhan area. All of these suppliers, there are alternate sources, and we're obviously working on mitigation plans to make up any expected production loss... With respect to supply sources that are outside the Wuhan area, the impact is less clear at this time."

Table 2

U.S. Technology Companies' Revenue Exposure To Apple Inc.
Companies >20% 10-20% <10%

Qorvo Inc.

32%

Jabil Inc.

22%

Lumentum Holdings Inc.

21%

Broadcom Inc.

20%

TTM Technologies Inc.

15%

Amphenol Corp.

12%

Qualcomm Inc.

x

Amkor Technology Inc.

x

Analog Devices Inc.

x

Corning Inc.

x

Flex Ltd.

x

II-VI Inc.

x

Intel Corp.

x

Maxim Integrated Products Inc.

x

Microchip Technology Inc.

x

Micron Technology Inc.

x

NVIDIA Corp.

x

NXP Semiconductors N.V.

x

Sanmina Corp.

x

Seagate Technology PLC

x

Texas Instruments Inc.

x

Western Digital Corp.

x
Notebooks and servers

We believe the recent U.S.-China trade spat prompted notebook OEMs (and their contract manufacturers such as Quanta Computer Inc., Inventec Corp., Compal Electronics Inc., Pegatron Corp., and Wistron Corp.) to consider relocating manufacturing and assembly capacity from China to countries such as Taiwan, Vietnam, the Philippines, and Indonesia. However, we do not believe this has taken place quick enough for notebook OEMs such as Dell Technologies Inc. and HP Inc. to absolve them from potential supply chain disruptions from the outbreak.

Similar to Apple's iPhone, global manufacturing and assembly of notebooks are highly concentrated in China. Given continued strong demand for commercial notebooks as a result of the Windows 10 refresh cycle, we expect notebook OEMs' sales will slow if the production disruption lingers, with Dell feeling the effects sooner than others given its just-in-time production model. Still, we believe sales would be merely delayed, rather than lost.

The servers supply chain depends less on China compared to notebooks. We believe most server motherboards are prepared in Taiwan, and finally assembly is done in Mexico, the Czech Republic, and China for sales in their respective regions. While server pricing could be affected given potential demand-supply dynamics of input costs, such as memory and other semiconductor components, we do not expect this to hit supply chain members.

Table 3

Key U.S. Hardware Firms' China Exposure
Issuer Rating/Outlook Revenue Exposure To China China Property, Plant, and Equipment China Manufacturing Exposure Direct Business Impact From Coronavirus Outbreak

Corning Inc.

BBB+/Stable 24%

About 14% of total

Display glass manufacturing operations, optical fiber manufacturing facilities, cabling operations, hardware and equipment product manufacturing, glass lens and window components and assemblies, substrate and filter products. Medium

HP Inc.

BBB/Stable

No non-U.S. country more than 10%

Less than 10% of total

Facilities in Weihai, Chongqing, Shanghai. Medium

Hewlett Packard Enterprise Co.

BBB/Stable

No non-U.S. country more than 10%

N/A

The manufacture of product components, final assembly of products, and other critical operations concentrated in certain places, including China. Low

Dell Technologies Inc.

BB+/Stable

No non-U.S. country more than 10%

Less than 10% of total

Owns manufacturing facilities in the U.S., Malaysia, China, Brazil, India, Poland, and Ireland. Medium

Seagate TechnologyPLC

BB+/Stable

Less than 4%

About 3% of total

Disk drive assembly and machine learning operations primarily at facilities in China and Thailand. Performs subassembly and component manufacturing operations at facilities in China, Malaysia, Northern Ireland, Singapore, Thailand, and the U.S. Low

Ciena Corp.

BB+/Stable

APAC: 14%

N/A Supply chain includes certain direct and indirect suppliers based in China that supply goods to Ciena, its manufacturers, or third-party suppliers. Low

Western Digital Corp.

BB+/Negative 23%

About 15% of total

Vertically integrated manufacturing operations for flash-based products concentrated in three locations, with business ventures with Toshiba Memory Corp. in Yokkaichi, Japan, and in-house assembly and test operations located in Shanghai, China, and Penang, Malaysia. Low
N/A--Not applicable. APAC--Asia-Pacific.
EMS/distributors/components

North American firms have relatively high exposure to tech supply chain disruptions. EMS providers tend to have a high proportion of their revenue, at 20%-25%, from China and rely on a fully functioning transportation and logistics system to ensure parts are delivered on time and finished goods can be shipped to customers. Jabil's revenue from China is even higher, estimated at 40%-50%, because of Apple exposure. While shifting certain manufacturing activities outside of China could be an option, the time and added costs could prove prohibitive. It is unclear how long local quarantines will continue and when public transportation will return to normal.

We expect the coronavirus outbreak to have a meaningful impact on TTM's business. TTM is a PCB manufacturer. The company's first-quarter revenue guidance is down mid-single-digit percentages year-over-year. If factory shutdowns extend beyond Feb. 10, its financial results will be impaired further. Also, the estimated impact doesn't consider if TTM's customers are down for longer or have different supply chain issues (as the guidance contemplates only direct impact on the company). From a ratings perspective, TTM's recently announced plans to divest its mobility business and reduce its manufacturing footprint in China could be a compensating factor if proceeds will be used for debt repayment.

Our rating outlooks on most of these issuers are stable. However, if production suspension is protracted and liquidity becomes strained, it could result in negative rating actions on some of these issuers.

Table 4

Select EMS, Distributors, And Components Companies’ China Exposure
Issuer Rating/Outlook Revenue Exposure To China China Property Plant & Equipment (PP&E) China Manufacturing Exposure Comments From Latest Public Disclosure Direct Business Impact From Coronavirus Outbreak

TE Connectivity Ltd.

A-/Stable 18%

About 18% of total

Sizable operations in China, including 18 principal manufacturing sites. From Jan. 29, 2020, earnings call: "We don't have operations or factories in the Wuhan (area)...We are in the middle of the Lunar New Year celebration, and that we are running lower shifts right now...And then some of the industrial parks we serve, they are actually shutting in an extra week...it is an uncertainty that we have, but we have those uncertainties in many parts of our business every day." Low

Amphenol Corp.

BBB+/Stable 32%

About 31% of total

N/A No mention of coronavirus impact on its earnings call. Low

Flex Ltd.

BBB-/Stable 25%

About 22% of total

Approximately 80% of manufacturing capacity in emerging markets, including Brazil, China, Hungary, India, Indonesia, Malaysia, Mexico, Poland, Romania, and Ukraine. From Jan. 30, 2020, earnings call: "It's too early for us to quantify any potential impact . ... Our guidance excludes any potential impact from the coronavirus outbreak. ... We don't have any factories in the Hubei province, where the bulk of the issue is. The number of people that we have deployed there and our assets have come down significantly because of all the diversification efforts that we have taken in the past year. ... We're working with the government agencies to look for exceptions wherever possible." Medium

Jabil Inc.

BBB-/Stable N/A

About 38% of total

Operations in facilities worldwide, including China, Hungary, Malaysia, Mexico, Singapore, and the U.S. N/A High

Avnet Inc.

BBB-/Stable

13%

Asia-Pacific (APAC): less than 10%

N/A From Jan. 23, 2020, earnings call: "We'll see what happens with some of the supply lines coming out of China. But at this juncture, we have not seen an impact. But if it gets worse and they start shutting down airplanes, etc., then that will have a different effect on shipments of China." Medium

Arrow Electronics Inc.

BBB-/Stable

N/A

APAC: 5%

N/A From Feb. 6, 2020, earnings call: "We are seeing some delays and longer lead times of products manufactured in China due to business and transportation shutdowns and the extension of the New Year holiday week mandated by the Chinese government. We cannot quantify the impacts on our business at this time. ... We've got plenty of inventory. ... It's the ability to move the inventory around. ... Foxconn was going to start producing again on the 10th or 11th (of February). So it doesn't look like it's going to string out too far. ... we can't really put a frame around the guidance because we don't know the exact date." Medium

Sanmina Corp.

BB+/Stable

About 22% of total

Active manufacturing facilities in China. From Jan. 27, 2020, earnings call: "We will continue to watch this very, very carefully and take necessary steps. But so far, the impact on our supply base is very much under control, but we have to continue to monitor this very, very carefully." Medium

Belden Inc.

BB/Stable 5% N/A Two manufacturing facilities in China. From Feb. 4, 2020, earnings call: "So from a demand point of view in China, we have some direct exposure, although not a lot ... to the extent that factories in China are not producing, that could certainly have an impact on their demand for machinery out of Europe and out of Germany. It could also have an effect on their ability to deploy labor into installations, either in factories or buildings. ... We're not going to have production back up and running again until the 10th of February in a couple of our facilities. We might see some demand push from (the first quarter) to (the second quarter). ... We're also going to pay very close attention to the exports out of Germany into China." Low

Celestica Inc.

BB/Negative 21%

N/A

China listed as major PP&E location. Sites provide manufacturing services and solutions. From Jan. 29, 2020 earnings call: "We do about $1 billion a year of revenue in China across two large manufacturing facilities in Suzhou and Songshan Lake. ... We don't think it's going to be a huge impact, but it's a very dynamic situation. ...And we have contingency plans in place." Medium

TTM Technologies Inc.

BB/Negative 19% About 39% of total Nine PCB fabrication plants located in Hong Kong, Huiyang, Dongguan, Guangzhou, Shanghai, Suzhou and Zhongshan, China, and three custom assembly and system integration operations in Shanghai and Shenzhen, China. From Feb. 5, 2020, earnings call: "If the coronavirus outbreak causes the government to extend the factory shutdown beyond Feb. 10, our financial results will be negatively impacted. ... These aren't orders that are going away. These are orders that we're going to do our best to service either as we come out of Chinese New Year out of our existing facilities. ...It may result in delays on certain aspects of production. ... (Our customers) are dealing with an industry in printed circuit boards, where 70% approximately of board production is in China...so sure that can be pull-ins in certain places. It also can be pushouts in products that they're deprioritizing." High
EMS--Electronic manufacturing services. N/A--Not applicable.
Semiconductors

China consumes 40%-50% of global semiconductor output, for both domestic consumption and assembly bound for export. As a result, U.S. semiconductor firms have high revenue exposure to China. And factory shutdowns or underutilization of production facilities could lead to order cuts and, in turn, fewer or delayed sales.

China consumes roughly 30% of global light-vehicle production, so the auto end market's vulnerability could affect parts of this market because of increasing semiconductor content in vehicles. According to S&P Global Ratings' auto team estimates, shutdowns in China are likely to knock 2%-4% off total annual production in the Wuhan region, which is home to about 9% of Chinese auto production. China may further extend shutdowns beyond Hubei to limit contagion risk, possibly affecting up to half of China's auto and auto-parts production (see "The Coronavirus Dashes Recovery Hopes For Global Autos," Feb. 5, 2020). Issuers with large auto exposures such as NXP Semiconductors N.V., Texas Instruments Inc., Analog Devices Inc., and Maxim Integrated Products Inc. could see orders pushed out if auto production slows.

Semiconductor firms with high revenue exposure to Apple, such as Qualcomm Inc. and Broadcom Inc., will likely be affected over the near term. Qualcomm commented that its modem shipment will be down 13% sequentially in the March 2020 quarter, about 14% lower than analysts' consensus expectation, incorporating the potential demand change due to the coronavirus. Its competitor, Taiwan-based MediaTek Inc., lowered its 2020 forecast for 5G smartphone sales by 15% to 170 million units, citing concerns over coronavirus and its impact on Chinese consumption. The impact on memory semiconductor vendors is less clear because output shortages from Samsung, SK Hynix, and Micron Technology Inc.'s manufacturing facilities in China could increase average selling prices, providing some offsets. Any production disruption will exacerbate the current trend of rising NAND average selling prices and help DRAM achieve demand supply equilibrium more quickly. This would also raise the input costs of products such as notebooks, servers, smartphones, etc., potentially hurting these OEMs' profitability.

While we haven't taken rating actions on any U.S. semiconductor firms as a result of the coronavirus outbreak, we are closely monitoring new developments that could impair II-VI Inc. and MACOM Technology Solutions Holdings Inc. They have less cushion within the ratings.

We also expect II-VI Inc.'s business to be significantly affected by the coronavirus. II-VI is an optical components and subsystems supplier. The company provided March 2020 quarter guidance that includes an estimated minimum $50 million (8%) reduction in revenue. It will try to shift some of its manufacturing to factories in Malaysia and Vietnam to reduce production losses. Leverage as of December 2019 is in the mid- to high-4x area versus our rating downside trigger for leverage sustained above 5x. Its ability to mitigate the outbreak and achieve targeted cost savings will be important to our near-term rating assessment.

MACOM's ongoing revenue declines from industry and macroeconomic issues will likely be extended in the first quarter if its Chinese customers' facilities remain closed for longer than expected. Our prior expectation for adjusted leverage to improve to 11x-12x and about $20 million free operating cash flow in fiscal 2020 will likely prove optimistic. MACOM is an analog semiconductor manufacturer.

Table 5

Select Semiconductor Firms' China Exposure
Issuer Rating/Outlook Revenue Exposure To China China Manufacturing Exposure End Market Breakdown Comments From Latest Public Disclosure Direct Business Impact From Coronavirus Outbreak
Non-Memory Semiconductors

Intel Corp.

A+/Stable

28%

Memory facility in China. DCG (cloud, enterprise, communications infrastructure; 33%), Internet of Things (retail, industrial, smart infrastructure, vision; 5%), Mobileye (auto; 1%), NSG (SSDs; 6%), PSG (communications, cloud, enterprise, embedded; 3%). N/A Low

Texas Instruments Inc.

A+/Stable 44% Manufacturing facilities in Chengdu and Shanghai for both analog and embedded processing segments. Industrial (36%), auto (21%), personal electronics (23%), comms (11%), enterprise (6%). N/A Medium

Applied Materials Inc.

A-/Stable 29% Owns and leases offices, plants, and warehouses worldwide, including Europe, Japan, North America (principally the U.S.), Israel, China, India, Korea, southeast Asia, and Taiwan. Smartphones and other mobile devices, servers, personal computers, automotive devices, storage, and other products. N/A Low

Qualcomm Inc.

A-/Stable 48% including Hong Kong Back-end manufacturing facilities in China, Germany and Singapore. Mobile, automotive, computing, IoT, and networking. From Feb. 5, 2020, earnings call: "There is significant uncertainty around the impact from the coronavirus on handset demand and supply chain…we are widening and reducing the low end of our guidance range … ." Medium

NVIDIA Corp.

A-/Stable 24% including Hong Kong Manufacture of product components, final assembly, and other critical operations concentrated in certain geographic locations including Taiwan, China, and Korea. Gaming (53%), professional visualization (10%), datacenter (25%), automotive (5%), original equipment manfucaturers and intellectual property (7%). N/A Low

Lam Research Corp.

BBB+/Stable 22% No manufacturing facilities in China. Leases or owns properties for service, technical support, and sales personnel throughout the U.S., China, Europe, Japan, Korea, southeast Asia, and Taiwan, and leases or owns manufacturing facilities in Ohio and Korea. Electronic products including mobile phones, personal computers, servers, wearables, automotive vehicles, and data storage devices. N/A Low

KLA Corp.

BBB/Stable 27% Principal manufacturing activities take place in the U.S., Singapore, Israel, Germany, U.K., Italy, and China. N/A From Feb. 4, 2020, earnings call: "We do not expect a protracted disruption of our business. ...Policy changes regarding the response could affect our ability to ship and support shipments into China as well as to access key components from our China-based supply chain necessary. ...The range of guidance has been widened. ... This revenue guidance would have approximately been 3%-5% higher at the midpoint without the adjustments for the coronavirus impact. ... There's an impact to the specialty semiconductor business in Wuhan, in Hubei province, an impact to the flat panel business and to process control." Low

Maxim Integrated Products Inc.

BBB+/Stable 35% No manufacturing in China. Automotive, communications and data center, computing, consumer, and industrial markets. N/A Low

Analog Devices Inc.

BBB/Stable 22% No factories in China . Industrial (50%), comms (21%), auto (16%), consumer (13%). N/A Medium

NXP Semiconductors N.V.

BBB-/Positive 36% Back-end facilities for micro-controllers, analog and sensors. Automotive, identification, wireless infrastructure, lighting, industrial, mobile, consumer, computing, and software solutions for mobile phones. From Feb. 4, 2020, earnings call: "As of today, we've seen no impact on orders. Although we're just coming out of the Lunar New Year holiday, clearly, the forced closures by some of the additional provinces in China, add more to the uncertainty and to be clear. It's just impossible for us to speculate on the impact and the implications associated with it. Our guidance today does not contemplate any potential impact from the coronavirus." Medium

Broadcom Inc.

BBB-/Stable 35% N/A Data center, telecom, enterprise, embedded networking, mobile, industrial, automotive. N/A Medium

Qorvo Inc.

BB+/Stable 57% Module assembly and test facilities in Beijing and Dezhou, China. Mobile devices, cellular base stations, defense and aerospace, Wi-Fi customer premises equipment, smart home, and automotive connectivity. From Jan. 29, 2020, earnings call: "To date, we've seen no material impact for our supply chain or with demand signals. However, the situation is evolving. ... We're thinking about potential effects into the June quarter. And even though our channels are lean, we are concerned about how this plays out because we just don't know." Medium

Amkor Technology Inc.

BB/Stable Asia-Pacific 12% Factory in Shanghai. In 2016, expanded clean room space by nearly 45%, to a total of about 625,000 square feet. Serves both international and local customers, with a heavy emphasis on wafer-level packaging, wafer bumping, stacked die packaging, and advanced test services. Communications (44%), auto, industrial (26%), computing (18%), consumer (12%). From Feb. 10, 2020 earnings call: "Today, all the Amkor factories are fully operational and sufficiently staffed to meet customer demand. We are dealing with some minor, relatively isolated supply issues. Our first quarter forecast takes those supply issues into account as well as the incremental costs associated with our employee protection efforts. At this point, we have seen no meaningful changes in our demand profile as a result of the coronavirus outbreak." Low

Microchip Technology Inc.

BB/Stable 22% No manufacturing in China. Automotive, aerospace, defense, space, communications, computing, consumer, and industrial control markets. From Feb. 4, 2020, earnings call: "Our manufacturing footprint in China is small, and we expect little impact to our operations from (the extension of holidays to Feb. 13 in Hubei province). ...We do not anticipate any significant supply chain issues for materials sourced from China. ... We have no way to model how the rest of the quarter will play out for the coronavirus situation, and what the consequent business impact may be." Low

II-VI Inc.

BB-/Stable 21% 45%-50% of employees are based in China. 80% of those are located in Wushi and Fuzhou with none in the Hubei province. Communications, materials processing, aerospace and defense, semiconductor capital equipment, life sciences, consumer electronics, and automotive. From Feb. 10, 2020, earnings call: "The effects are potentially broad reaching. ... We expect to be moving back to full strength over the next several weeks. We have, therefore, included a minimum of $50 million revenue reduction in our guidance to account for these conditions. ... On the coronavirus, I want to tell you that our order book for the third quarter as we closed (Dec. 31) was extremely strong. ... We had a significant amount of employees work through Chinese New Year. They were registered with the local government. This was allowed." High

Lumentum Holdings Inc.

BB-/Stable

~15-20%

Significant manufacturing facilities are located in the United States, Thailand, China, the United Kingdom, Slovenia, Italy, Japan, and Switzerland. Telecom (50%), datacom (11%), consumer and industrial (27%), lasers (13%). From Feb. 4, 2020, earnings call: "In our factory in Shenzhen, China, employees have been impacted by travel restrictions and the extended Lunar New Year holiday. For some products, the supply of externally purchased material is being impacted. ... The guidance incorporates an approximate $15 million-$20 million reduction in revenue at the midpoint and a wider-than-normal revenue range due to the coronavirus outbreak ... we had a workforce working through the Chinese New Year at about 50%. So those employees were working and staying at the dorms and weren't restricted by travel restrictions. Over the last three years, we did move a substantial percentage of our production out of a contract manufacturer in Shenzhen, China to our own factory as well as in the contract manufacturer in Thailand. ...we've looked at the sourcing of those components that could come from China. And we feel pretty comfortable that our Thailand contract manufacturer and our own operations will be minimally impacted by those sourcing of components coming from China." Medium

MACOM Technology Solutions Holdings Inc.

B-/Stable 26% No main facilities in China - only design centers and local sales offices Telecom (36%), data center (23%), industrial and defense (41%). N/A Medium
Memory Semiconudctors

Micron Technology Inc.

BBB-/Stable 15% Component assembly and test, module assembly and test facilities in China Mobile (25%), PC and graphics (20%), enterprise and cloud server and storage (40%), auto, industrial, and consumer (15%). From Feb. 11 Goldman Sachs Tech Conference: "So some of our customers have supply chain in China, where they manufacture product, not just for consumption within greater China, but also in other parts of the world that they ship products out of China. ... It seems that maybe there is some impact to certain supply chains, notably in the PC, laptop arena, and the mobile phone arena. ... There has been an impact to demand in China. ... maybe about a 1.5-point impact to China GDP is what many analysts are talking about in calendar (first quarter). And that obviously impacts various parts of the technology supply chain across the whole bunch of technology products." Low

Western Digital Corp.

BB+/Negative 23% Vertically integrated manufacturing operations for flash-based products are concentrated in three locations, with business ventures with Toshiba Memory Corp. located in Yokkaichi, Japan, and in-house assembly and test operations located in Shanghai, China and Penang, Malaysia. Client devices (mobile, desktop, gaming and digital video hard drives, SSDs, embedded products and wafers; 49%); data center devices and solutions (capacity and performance enterprise HDDs, enterprise SSDs, data center software and system solutions; 30%); and client solutions (removable products, hard drive content solutions and flash content solutions; 21%). From Feb. 11 Goldman Sachs Tech Conference: "From a supply standpoint, we have two factories in China. Those were operating through the Chinese New Year. They continue to operate. Although we see some small perturbations that you might expect, but nothing that meaningfully impacts our operations in the current period. Flipping to the demand side. ... It's a little too early to tell. Nothing that meaningfully impacts our view of the current quarter reporting, but that's continuing to evolve, and we have to continue to see how things go." Low
N/A--Not applicable. PP&E--Property, plant, and equipment.

How Coronavirus Will Affect Europe, The Middle East, And Africa

In Europe, the heavy software and services mix of tech companies leaves the sector relatively less exposed. Semiconductor makers Infineon Technologies AG and STMicroelectronics N.V. are exceptions. Each generates about a third of its revenue from the China region, through sales of semiconductors to a variety of end markets in the automotive and industrial sectors, both directly to OEMs and through their channel partners. However, at this time we do not anticipate ratings impact for either.

Given their relative exposure, we estimate a 10% decline in China-based demand would reduce overall sales by 3%-4% for the two companies. This could be a short–term difficulty if a significant portion of their customers' factories in China reduce or suspend operations. However, our current base-case assumption of underperformance focuses on the January-March 2020 quarter, with recovery by September 2020 and above-trend growth in following quarters. This should narrow the negative impact by the end of 2020 and allow for a catch-up in 2021 as manufacturers address pent-up demand and replenish inventories. This assumption reduces the likelihood of negative rating actions based on January-June underperformance unless we decide to extend our timeframe for expected impact from the viral outbreak.

Several additional factors should also help to partly mitigate the short-term risks for Infineon and STMicro. In terms of production, both are relatively well positioned. They only rely on one or two main fabs in China, with most production insourced and in other countries, including a significant European presence. This may give Infineon and STMicro some production advantages relative to China-reliant peers if upstream interruptions are prolonged and shortages emerge. In addition, we expect lower sales into their downstream markets could be partly offset by reduced need for capital spending, helping to maintain cash flow measures despite lower revenue. We could also see reallocation by manufacturers to capacity outside of China, potentially making up for supply-chain issues in China.

Expect Rating Impact To Hardware OEMs And Semiconductor Firms If Supply Chain Disruption Persists

We should expect rating pressure on tech companies if the coronavirus takes longer to contain, which means the policy measures designed to limit the spread would remain in place for a sustained period. The negative effect would not be linear as the collapse of any part of the China manufacturing hub could have an outsize effect on the overall function of the global supply chain. Global tech spending could take a hit as a result.

Also, we expect more tech companies to diversify reliance on China as a manufacturing hub. As with the U.S.-China trade tensions over the past two years, the coronavirus outbreak will serve as a reminder that geographic concentration has its benefits, but also costs. While China continues to have an abundant and skilled labor force, it no longer has the comparative advantage of lowest labor costs, providing economic incentives for a pivot.

Although it might be costly to relocate manufacturing facilities, given startup costs and low productivity initially, the benefit of avoiding unexpected geopolitical events or health emergencies provides important reasons for tech companies to consider re-engineering their manufacturing processes and diversifying their production facilities.

Related Research

  • Coronavirus Casts Shadow Over Credit Outlook, Feb. 11, 2020
  • Coronavirus To Inflict A Large, Temporary Blow To China's Economy, Feb. 6, 2020
  • The Coronavirus Dashes Recovery Hopes For Global Autos, Feb. 5, 2020

This report does not constitute a rating action.

Primary Credit Analysts:David T Tsui, CFA, CPA, San Francisco (1) 212-438-2138;
david.tsui@spglobal.com
Raymond Hsu, CFA, Taipei (8862) 8722-5827;
raymond.hsu@spglobal.com
Mark Habib, Paris (33) 1-4420-6736;
mark.habib@spglobal.com
Secondary Contacts:Andrew Chang, San Francisco (1) 415-371-5043;
andrew.chang@spglobal.com
Makiko Yoshimura, Tokyo (81) 3-4550-8368;
makiko.yoshimura@spglobal.com
Research Contributor:Lisa Chang, San Francisco + 1 (415) 371 5015;
lisa.chang@spglobal.com

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