How do you survive and thrive in the semiconductor industry during a period of high inflation, fluctuating demand and uncertain supply?
GlobalFoundries’ method has been its increasing reliance on long-term agreements (LTAs) with some of its biggest customers, promising dedicated supply capacity for those customers and incremental revenue via prepayments for GlobalFoundries over the life of the contract. During GlobalFoundries fourth quarter and full-year 2022 earnings call this week, CEO Tom Caulfield and CFO Dave Reeder discussed how the strategy is paying off.
Caulfield said that forging LTAs with foundry customers is not only about establishing long-term demand visibility and building or allocating capacity to match, but also about creating “the best economics for both partners.” He added later, “Look, for me, it’s pretty simple. This is a single-source business by and large. Customers are looking to secure their supply. In some cases, it requires investment. The only way the investment can be made and make economic sense for both parties is if we both put our balance sheets in there.”
During somewhat soft demand periods, such as the current one, LTAs also help investors, and the company itself, see the forest and not just the trees. GlobalFoundries now has 40 LTAs, having added 10 of those agreements during 2022 and two of them during the final quarter of the year, including a “first of its kind” dedicated supply agreement with auto giant GM and extension of an existing Qualcomm LTA. The company also had a recent LTA with Motorola. In the process, GlobalFoundries has secured more than more than $5 billion of incremental lifetime revenue.
But another benefit not discussed quite as often is that LTAs often help boost revenue because dedicated or guaranteed supply can be sold at a price that is more attractive to the supplier, especially when inflation has kicked in at the time the deal is made. Thus, even though GlobalFoundries wafer shipments were down year-over-year in the fourth quarter, revenue came in higher as “average selling price increased approximately 20%, driven by ramping long-term customer agreements with better pricing,” Reeder said.
“The total value of these LTAs is now at $27.5 billion,” Reeder said. “Additionally, the amount of committed prepayments and capacity reservation fees have increased 34% from a quarter ago to approximately $5 billion. Our LTAs continue to serve as a solid foundation for working with our customers during times of demand uncertainty.”
The LTA evolution
GlobalFoundries may be a case study of an LTA success story, but LTAs also represent the general direction that the broader semiconductor industry is moving in, said Jack Gold, president and principal analyst of J. Gold Associates.
The catastrophic chip shortage that occurred during the Covid-19 pandemic fundamentally altered the business arrangements being made across the semiconductor ecosystem. In the past, most large buyers had “just in time” agreements with their suppliers, and assumed that product would be there when needed, Gold said.
“It worked pretty well and any spot shortages were quickly alleviated through a short term inventory investment that assumed it would be perhaps a few weeks at most for shortages to resolve,” he said, but added that the pandemic showed the ecosystem that unforeseen external factors require companies to think more about the long-term view, and putting “longer term supply agreements in place to make sure you are not boxed out of the market, and especially given that there is no real excess inventory of supply to tap into. So they are moving to a longer term supplier agreement, which is beneficial to both the customer and the foundry, like GF. They have a long term commitment to know how much to build over time so they don’t have to stock inventory and can plan their manufacturing better, and their customers, like GM, have a committed production schedule of parts over a longer term and don’t have to worry about scurrying around to try and find alternative supplies/suppliers.”
While the pandemic changed how the chip sector does business, LTAs also were built into GlobalFoundries long-term plan before that happened, as early as 2018, when the company began to organize itself around a vision to become a single-source provider to more of its clients. LTAs were seen early on as a tool to help achieve that, and one that the company discussed in detail leading up to its IPO in the fall of 2021.
The arrangements in particular can benefit buyers of chips who have their own hard and fast deadlines to meet for production of their own products. This is certainly the case in the auto industry, where manufacturers need to have enough of the right chips to power the connected, autonomous and electric vehicles they expect to produce for a given model year.
The LTA with GM was especially significant as GlobalFoundries sees automotive market growth that surpasses growth rates in sectors like communications and data centers. Reeder said full-year automotive revenue grew about 30% year-over-year in 2022, and that “based on our current design wins and ramp profile, we now expect almost $1 billion of automotive revenue in 2023.”
The automotive also may test the strength of LTA partnerships, however. Gold said, “Sudden increased volumes of sales of cars, for example, may require that GlobalFoundries produce more chips for GM. But if their factory is already committed, they may not be able to.”
The opposite is possible as well, as Gold asked, “What if the car market suddenly tanks and GM can’t sell cars?” In that case, GM already has a commitment to buy some number of chips and may have to eat its supply and wait for the market to bounce back unless GlobalFoundries and GM can work together on alternatives.
Caulfield believes that the ability to manage such wrinkles is built into the LTA model, allowing GlobalFoundries to negotiate with customers as short-term market fluctuations occur.
He said, “I think the LTAs are doing exactly what we talked about in our [investor] roadshow over a year ago and through 2022: creating security for both businesses to have long-term supply and the work through industry cycles in a partnership mode.”