Company description: Key player in compound semiconductor supply chain
IQE is the largest outsourced supplier of advanced wafer products and wafer services to the compound semiconductor industry. Its wafer foundries take very thin discs of substrate (compound semiconductor, silicon or silicon carbide) up to 150mm in diameter and deposit a succession of thin layers on them. Up to 400 epitaxial layers may be deposited, each of which may be only a few atoms thick. Each separate epitaxial layer contains a different combination of elements to give specific electrical or optical properties. By precisely controlling the thickness and composition of the layers deposited on the substrate, IQE provides customised epitaxial wafers (epiwafers) that meet each customer’s specific electrical and optical requirements. The finished epiwafers are sold to manufacturers of high-frequency chipsets and laser chips. These carry out further processing steps to create finished chips, which are then integrated into products such as mobile phones, datacomms equipment and automobiles.
Exhibit 1: Compound semiconductor supply chain
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Source: Edison Investment Research
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IQE has over 200 patents and a rich pool of trade secrets, enabling it to offer a wider range of technologies than its competitors and many in-house epitaxy units. This gives a strong competitive advantage and means it can benefit from growth in multiple markets. The group is continually refining its advanced epitaxy skills to create innovative value-added, materials-based solutions for its customers. As IQE’s IP portfolio has expanded, the dynamics of customer engagement have changed from an outsourced epitaxy manufacturer to a sought-after technology adviser.
IQE has facilities in Europe, the US and Asia, giving it a presence in all three major semiconductor manufacturing regions, supporting relationships with multiple non-US and US customers. As a result, although the current period of supply chain adjustment has affected profits short-term, IQE is beginning to gain replacement business with the Asian chip manufacturers who are picking up work from US chip manufacturers banned from supplying Huawei. This should make it relatively agnostic to any mid- to long-term shifts in market share between component manufacturers or OEMs.
IQE was founded in 1988, employs around 675 people and is headquartered in Cardiff, Wales. The shares were admitted to the London Stock Exchange in 2000.
Markets: IP accesses multiple verticals
Compound semiconductors are made from a mixture of elements. By combining elements (eg gallium, arsenic, indium, antimony, phosphorus and aluminium) in different proportions, IQE can make compound semiconductor materials with a diverse range of optoelectronic and electronic properties, each optimised for a particular market segment. These include materials that transmit and receive wireless, radio frequency (RF) or infrared (IR) signals, emit and detect light (photonics), convert light energy to electrical energy (photovoltaics) and can function at high voltages (power electronics). This diversity contrasts with silicon semiconductors, which are based on a single element and therefore have a fixed set of electronic characteristics, limiting their performance in key optical, RF and high-power applications.
The range of technologies that IQE offers means it is engaged in multiple markets, each with different growth trajectories. The wireless segment was the principal driver in the decade from 2004 and at 63% of FY18 revenues remains IQE’s largest segment. However, photonics (36% FY18 revenues) has taken over as the primary growth engine and it is expected to retain this role during the rest of the forecast period.
Exhibit 2: Growth drivers
Next 18 months |
Next two to three years |
Longer term |
5G Infrastructure roll-out: 5G base stations; GaN-on-Si; GaN-on-SiC |
5G infrastructure rollout: GaN for mm Wave/small cell network; lasers for backhaul networks |
Environmental and health monitoring |
Asian market wireless demand: power amplifiers for handsets |
5G handset opportunity: filters and switches (cREO) |
LiDAR for autonomous vehicles |
High speed datacomms: 10G and 25G distributed feed-back lasers;10G and 25G avalanche photo-diodes; PIN detectors |
3D sensing: low end smartphone; wearables/consumer devices; commercial and industrial applications |
Connected devices |
3D sensing: Android market (high/mid end); world facing camera (time of flight) |
Integrated optical front-end for smartphones |
Smart grids |
Wireless market
The memory and data processing chips in a mobile phone are typically silicon, but the transmit and receive functions are gallium arsenide (GaAs), especially in higher-specification handsets. This is because GaAs power amplifiers operate at higher frequencies and are more efficient than their silicon counterparts, thus enabling longer times between battery charges.
Weak smartphone market in H119 exacerbated by US-China trade tension
Management estimates that prior to the supply chains shifts caused by US-China IQE had around 50% of the global merchant wireless epitaxy market so it provides a significant proportion of the epitaxial wafers used to make power amplifier chips. It is therefore highly sensitive to changes in demand for smartphones, with rising photonics revenues not always sufficient to compensate for a downturn in the smartphone market from causing a dip in IQE’s revenues. During H119 weakness in the global smartphone market (down 4% year-on-year to 695.0m units, according to Counterpoint Research) caused by lengthening mobile phone replacement cycles was exacerbated by wireless customers serving the handset market cutting back on inventory levels in response to the uncertainty over future demand and the potential impact of Huawei’s addition to the US Bureau of Industry and Security’s Entity List. The interconnected nature of the semiconductor supply chain meant many of IQE’s customers were affected either directly or indirectly. IQE’s wireless revenues fell by 29% year-on-year to £30.1m (45% of total). In November the group noted that its major RF chip customers in the US had continued to place low volumes of orders and reduce inventory. Although it has already begun to win business from Asian chip manufacturers benefitting from this switch, with three production tools already qualified by a major Taiwanese foundry and a further two in qualification, this is not sufficient to offset the reduction in the US short term, contributing to a reduction in FY19 guidance.
5G roll-out and demand for epitaxy in handsets
In November International Data Corporation noted that worldwide smartphone shipments increased by 0.8% year-on-year in Q319, reversing seven quarters of decline. Companies shipped a total of 358.3m smartphones during the quarter, which was up 8.1% from Q219. Counterpoint Research noted that 5G smartphones accounted for 2% of Q319 shipments, over 200% sequentially. Given that China has already started rolling out 5G networks ahead of an initial launch in November 2019, the research house believes the scale of the Chinese market should make 2020 the breakout year for 5G. It is not yet clear whether the additional functionality provided in the initial phase of 5G roll-out will be sufficiently compelling to reverse the reduction in smartphone volume demand seen over the past couple of years, particularly because the first phase appears very similar to 4G (see above), so we do not expect 5G to drive substantial growth in demand for IQE’s wireless epitaxy in the short term. Nevertheless, industry analysts Yole Développement expects the technological advances required by 5G will support 8% CAGR between 2018 (US$15bn) and 2025 (US$25.8bn) for the RF front-end market. IQE is qualifying next generation higher efficiency power amplifiers suitable for 4G and 5G handsets.
There are three main uses for 5G. Enhanced mobile broadband is effectively a progression from 4G LTE mobile broadband services with faster connections, higher throughput and more capacity. Ultra-reliable low-latency communications (URLLC) use the network for mission-critical applications that require uninterrupted and robust data exchange. Machine-type communications (mMTC) use the network to connect to a large number of low-power, low-cost devices in a wide area. Neither URLLC nor mMTC are expected to be deployed widely before 2021. In the first couple of years post launch, 5G will be transmitted at frequencies similar to 4G, so below 6GHz, and therefore achieve similar data throughput rates. 5G will not achieve faster throughput rates until it transmits at the higher frequencies (above 24GHz) available in the millimetre wave spectrum.
5G roll-out and demand for epitaxy in base stations
IQE is already supplying gallium nitride on silicon carbide (GaN-on-SiC) for low-volume, price-insensitive applications, primarily military communications and radar, and high-end base stations. Its newer, less expensive gallium nitride on silicon (GaN-on-Si) technology potentially opens up various more price-sensitive applications in the wireless infrastructure market from H220 onwards, displacing the incumbent silicon technology. This is particularly important as the wireless market shifts to 5G applications, as not only do GaN devices consume less power and last longer than their silicon counterparts, but they also enable the creation of smaller, denser arrays operating at higher frequencies. This is essential for 5G base stations, which will need to be more compact than their 4G predecessors and handle the transmission and reception of multiple inputs and outputs in parallel to cope with the processing requirements of the Internet of Things (IoT), Industry 4.0 and autonomous vehicles. Yole Développement predicts the global GaN RF market will increase from US$632m in 2018 to US$2bn in 2024, driven by telecom infrastructure and defence applications. We do not expect the first phase of 5G deployment, which will use some 4G infrastructure, to drive substantial growth in demand for IQE’s wireless epitaxy in the short term. We anticipate modest revenues from GaN-on-Si epitaxy in FY20 followed by volume ramp-up in FY21.
5G roll-out and penetration of switch and filter market
IQE’s newer technologies give scope for growing wireless revenues substantially more quickly than the market. Customer engagement on projects using IQE’s patented cREO technology to develop filters and switches for higher frequency 5G handsets is progressing well, potentially progressing to volume sales from FY21 and driving substantial growth in demand for IQE’s epitaxy. By 2023, IQE intends to deploy several of its new technologies including cREO, porous silicon and its single crystal epitaxial aluminium nitride wafers in an integrated front-end module combining power amplifiers, filters and switches on a single chip.
Exhibit 3: Size of front-end market
Component |
2017 market size |
2023 market size |
CAGR |
IQE technology |
Filters |
$8bn |
$22.5bn |
19% |
Rare earth oxide |
Antenna tuners |
$0.5bn |
$1bn |
15% |
- |
Switches |
$1bn |
$3bn |
15% |
Porous silicon |
Power amplifiers |
$5bn |
$7bn |
7% |
GaAs/dilute nitride |
Low noise amplifiers |
$0.2m |
$0.6bn |
16% |
GaAs |
Millimetre wave front-end module |
$0m |
$0.4bn |
N/A |
GaAs InP GaN |
Total |
$15bn |
$35bn |
14% |
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Source: Edison Investment Research, Yole Développement. Note: Shading indicates IQE’s presence in segment.
Our segmental estimates were revised downwards following the November trading update to reflect a greater than anticipated disruption to IQE’s major US wireless customers as a result of the US/China trade war exacerbated by destocking. We therefore model a 30% year-on-year reduction in segmental revenues during FY19. IQE has stated it expects Q120 to be seasonally weak but beyond that is cautiously optimistic. While the qualification of products and tools in the Asian supply chain for wireless RF noted above and 5G handset opportunities including penetration of the filter and switch markets support our view of a recovery medium-term, we model a further 1% decline in segmental revenues during FY20 to reflect the shift in RF chip output from the US to Asia.
Compound semiconductors exhibit properties that convert light to electricity and electricity to light extremely efficiently. IQE has developed a range of epitaxial wafers and substrates, which may be used to either emit or detect visible light and light in the infra-red part of the spectrum. Photonics devices are used in many different markets, so demand is not dependent on any one application in the way that historically, wireless revenues and consequently IQE’s fortunes, were reliant on the health of the handset market. Market segments include data communications, lighting, medical diagnostics, heating and consumer devices. Wafer prices for photonic applications are at least twice that for wireless applications. This gives a beneficial impact on IQE’s margins even though there are many more processing steps required than for wireless epitaxy.
VCSELs: Arrays of lasers for consumer and industrial applications
IQE’s growth during FY17 and FY18 was driven by demand for a specific type of photonics emitter: the VCSEL. We expect VCSELs to continue to be a key growth driver in future. VCSELs modulate signals at frequencies up to and exceeding 25Gbps, so are ideal for high-speed communications and precision sensing applications. They provide reliable operation at distances ranging from close proximity links (centimetres) up to 500m in data centre, enterprise and campus networks. Arrays of VCSELs are deployed in consumer electronics devices (including gaming devices, smartphones and tablets) for laser focusing, 3D imaging, facial recognition, proximity sensing, hand and body tracking and gesture recognition, and in automobiles for pedestrian detection, collision avoidance, parking assistance, traffic sign recognition and lane departure warning. Two-dimensional arrays consisting of hundreds of individual VCSEL light sources can collectively output a high-power beam tuned to a specific frequency. This has applications in industrial illumination, 3D printing, drying and curing plastics and sintering metals.
A report from Yole Développement in June 2019 estimated the global VCSEL market should exceed US$3.7bn by 2024, growing at a 31% CAGR between 2018 and 2024. This is based primarily on migration of VCSEL technology from flagship models to all smartphones and to a lesser extent the adoption of 3D sensing technologies in automotives. In the long term, the VCSEL market for LiDAR could generate a revenue of around US$800m by 2032. The report notes the total VCSEL cost (chip not epitaxy) per smartphone in 2018 was US$2–3.
IQE was the first company to have a process for producing 6” diameter VCSEL wafers. Having a higher diameter means more devices can be manufactured at the same time, substantially reducing cost per device. Being the first vendor to offer larger diameter VCSEL wafers meant IQE has become the preferred outsourcing supplier for VCSEL epitaxy, working in some cases directly with OEMs rather than only chip or component vendors. Taiwan-based Visual Photonics, which develops and manufactures epitaxial wafers, now has 6” diameter VCSEL wafer capability.US-basedFinisar, which manufacturers optical communications products, expects to start production in H120. However, IQE is conducting internal trials processing VCSELs on 8” wafers.
InP: Enabling high data rate fibre optic communications
Telecommunications companies are increasingly deploying passive optical networks to deliver triple-play services including TV, voice over IP phone and internet services to subscribers. These networks are also referred to as fibre to the home, fibre to the premises or fibre to the curb. These optical networks can deliver the much higher data rates that are essential for distribution of video and other internet services. Optical connections are also much more efficient than their electronic counterparts, which is particularly desirable in data centres, where power, including that required for cooling purposes, is a significant proportion of operating costs. Demand for these applications is being driven by 5G connectivity and the adoption of IoT. However, IQE’s major customer for InP is experiencing internal issues unrelated to IQE’s epitaxy.
IQE’s nanoimprint lithography (NIL) technology provides a route for manufacturing the distributed feedback (DFB) lasers used in short- (up to 20km) and long-haul networks with higher performance and lower manufacturing costs. DFB lasers may also be deployed in a wide range of emerging sensing applications such as 3D sensing, monitoring environmental emissions and air quality, detecting chemical weapons and explosives, and monitoring breath and blood vessels to aid disease diagnosis. In July 2018 IQE announced the NIL technology had been production qualified by a leading supplier of DFB lasers to the telecoms and data centre markets. It is in multiple customer engagements, including qualifications regarding use of the NIL technology in DFB lasers for 10G and 25G network components. This includes Asian chip vendors who typically lack the in-house expertise required to create technology such as NIL themselves. Management expects this to result in some volume sales during FY20.
One-stop shop for all types of IR materials
Compound semiconductor materials tuned to infra-red frequencies have revolutionised image sensing, providing images that are 8x sharper and can be generated 4x more quickly. These higher resolution images are key for AI applications that analyse visual data. Historically, this has been a high-margin business focused on defence applications such as night vision equipment. However, since IQE started to produce the industry’s first (and so far only) 6” indium antimonide wafers, the economics of production have improved. This permits the deployment of infrared chips in a wide range of high-volume, cost-sensitive applications such as environmental monitoring. It also permits the manufacture of very large sensing arrays that can detect data from sources further away. Being able to offer a more economic solution also opens the market longer term for deployment of infra-red lasers in non-invasive blood monitoring or for checking on levels of carbon dioxide.
Photonics leading FY20 recovery
IQE retains > 90% of the outsourced VCSEL market, which management estimates is between one-third and one-half of the total market. The company is benefiting from underlying market growth, a strong market position and component vendors transitioning from a vertically integrated business model towards outsourcing wafer supply from IQE. During H119 segmental revenues (which include those previously categorised as attributable to infrared products) grew by 18% to £35.5m (53% of total), reflecting multiple VCSEL ramp ups.
In July, IQE announced it had commenced VCSEL production at Newport (UK) for a second major customer, this one for 3D sensing in Android devices, and has extensive product qualification ongoing for several other VCSEL projects (currently 10 other chip customers). It is also engaging with multiple Asian chip companies on 10G and 25G lasers for data comms. Importantly, the chip customer behind the 2017 VCSEL production ramp up, which we have previously inferred is involved in the Apple supply chain, has extended its current contract until the end of 2021. Although Apple iPhone shipments were down 4% in Q319, Apple’s price cuts in China and elsewhere with the iPhone 11 and XR, as well as the introduction of a new palette of colours, appears to have stimulated demand during the last week of September offsetting the sharp annual decline earlier months which is a good sign going into the holiday season quarter. These observations support our assumption of sequential segmental revenue growth in H219 and 13.6% segmental revenue growth for FY19 as a whole. This is followed by segmental revenue growth of 17.5% in FY20. We note that a recent report from Mordor Intelligence stated the global photonic integrated circuit market was valued at US$472.5m in 2018 and predicted it would grow with a CAGR of 26.4% between 2019 and 2024.