A New Lease on Life Maximizing safety and success in the fast-moving world of semiconductor manufacturing
In the competitive world of semiconductor manufacturing, you need two things to stay ahead of the game state-of-the-art equipment and sufficient capital to get what you need, where and when you need it. In this era of multi-billion dollar semiconductor manufacturing facilities, we're talking here about hundreds of millions of dollars in capital equipment assembled under one roof. Happily, there are several ways to get access to that capital. You can borrow the money in a traditional sense to buy your equipment outright an option usually referred to as debt financing or you can leverage the present value of your money by leasing the equipment from a third party. Leasing is actually an alternative form of financing, but it's one that in many instances proves superior to the borrow-to-own option because leasing offers attractive levels of economic flexibility and optimization in your capital asset management strategy. ***************************** Buy versus lease So let's start by walking briefly through the buy-versus-lease decision. It's easy to contemplate the pros and cons of these strategies if you consider them in terms of your automobile decision. Should you lease your next Lexus or should you buy it? It's nice to lease your car, because when you want to trade up to the newer model, it's a straightforward process to accomplish that goal. However, sometimes it's even nicer to buy your next Lexus because there's long-term investment value in a Lexus and perhaps you want to be able to capitalize on that value. More importantly, perhaps you want to depreciate the value of the car as a business-related expense over the course of your ownership period. Clearly, whether to lease or buy a car is wholly dependent on these several factors your current ability to service the lease versus servicing the borrow-to-own financing contract, predictions as to the long-term appreciation of the car as a capital asset, your need to amortize the automobile as a business expense over the lifetime of the car, and your desire and/or ability to maintain and repair the car over its useful lifetime to you. If you buy the car outright, you're shouldering the maintenance and repair obligation. If you lease the car, the maintenance and normal repair of the car is traditionally shouldered by the leaseholder on the car, not you. This is considered to be a maintenance-lease type of deal and is quite widely used. Stop for a moment, however, and consider that there's also a type of lease less frequently, used but still out there with regards to your car. It's an arrangement whereby you opt to pay for the maintenance and repair of the car yourself over the lifetime of the lease. That's considered to be a net-lease type of contract arrangement and although it's available for cars, it's usually not part of the discussion in and around the less-than-profound financials involved in leasing an automobile. Net-lease discussions are more typically found in contemplating the financials involved in leasing super-expensive capital equipment. In any case, you can understand that there might be a choice available to you in leasing a car to cover the ongoing costs of operating the equipment yourself, or to let the leasing company shoulder that burden instead. Clearly that choice would be reflected in the terms of your lease; it would be reflected directly in the amount of the periodic payments required to service that lease. ***************************** Lease versus lease Okay. So let's say that after looking at the numbers, you've decided to lease your car. Or, closer to the spirit of our capital equipment discussion here, you and your financial team have decided to go with the leasing option to access needed state-of-the art equipment for your semiconductor fabrication facilities. Well, the decision making is not yet complete, because within the leasing option you're going to have to evaluate several additional choices. One is a traditional lease deal; you enter into a contractual arrangement with the third party who owns the equipment, and you pay on a specified, periodic basis for access to that equipment. That's a straightforward decision and one that's wholly comparable to our automobile example. There's another choice available to you and your team, however one that's not as comprehensible within the limited scale of automobile leasing. This slightly more obtuse option referred to as the sale-leaseback arrangement. This option is a more creative financing deal in which you buy the capital equipment, you sell it to a third party who takes on the liabilities of the ownership, and then turns around and leases the equipment back to you. You pay on the lease on a periodic basis for use of the equipment as stipulated by the contract through to the end of the arrangement. At this point, further decisions can be made as to final disposition of the equipment. At first glance, this may sound a bit confusing, but there's method in this madness which will become more clear on closer examination. But first whether you enter into a traditional lease contract or a sale-leaseback arrangement, there are certain obvious and fundamental decisions that color the nature of the lease, and these decisions apply to all types of leases. The decisions include setting the length of the lease, setting the period and amount of the payments on the lease, deciding as mentioned earlier who will be responsible for repairs and maintenance of the equipment the party who's leasing the equipment or the party who's providing the equipment via the lease arrangement and finally, saying aye or nay to certain options attached to the end of the lease including the ability to renew the lease or not and the ability to purchase the aged equipment at the end of the lease or not. These decisions are complex when you're leasing a car, but getting it right probably isn't going to make or break your financial viability or that of your household. When you're looking to lease semiconductor capital equipment, however, you simply can't afford to get these things wrong. The details of your lease the length, payments, maintenance options, and closing arrangements can indeed make or break the financial viability of the company, the numbers are that large. When you're dealing with capital on this scale tens of millions of dollars for a new stepper, for instance, or several hundred millions of dollars for a new wafer kiln you need more than just your gut feeling or the back of an envelope to calculate the impact of the various decisions. Whether you're a fab floor manager or the CEO at a semiconductor manufacturer, youre going to need some sound financial advice to understand the implications of how your lease is structured. That advice can and should come from a variety of sources. Most importantly, the internal team at the semiconductor manufacturer needs to be heavily involved in examining lease options for capital equipment, including the CEO, the CFO, and any senior management responsible for business or technical initiatives at the company. Ideally, fab and floor managers would also be party to those discussions. It's on the manufacturing floor where the equipment will be utilized and although floor managers may not be part of senior management, they nonetheless bring a vital perspective of the day-to-day operational realities of how the capital equipment is utilized. To assist the internal team in all of this, advice should also be sought out from parties external to the company people who have a vested interest in the success of the company including investors, bankers, auditors, and even representatives of the leasing agent itself. Many leasing enterprises have sophisticated financial talent on staff, who are able to sit down with potential customers and to help sort through the myriad, often confusing, and highly dense financial implications pros and cons of the lease you are about to enter into. Clearly before the final deal on any lease is signed, sealed, and delivered, your team needs to do the necessary homework to thoroughly understand the contract. As mentioned, that homework must include a complete set of consultations with the external parties who have the expertise to help with the decision-making process. ***************************** Sale-leaseback Clearly, hundreds of millions of dollars are tied up in semiconductor capital equipment, so it's a given that some kind of financing is going to be involved in getting access to that equipment. Within the lease financing option, let's look more closely at the sale-leaseback strategy. The principle thing to keep in mind when participating in this type of arrangement is to remember that the IRS and the Courts have established very important guidelines within which a sale-leaseback must operate. If the semiconductor manufacturer purchases, for instance, a $100 million piece of equipment, sells it to a leasing entity at full market value, and then leases it back, this is a sale-leaseback and there are benefits to both parties involved. The manufacturer has access to the $100 million, in part to service the lease and in greater part to grow and nurture the manufacturing operations hopefully to the next level of revenue success. The leasing agent has ownership of the equipment, which means having access to the tax benefits related to the depreciation. The lessor is also more or less guaranteed full utilization of the equipment by way of the specific manufacturer who has leased it back. The leasing entity has essentially purchased a piece of equipment that will be 100-percent utilized as a profit center for the company. What are the characterizations of the contract, then, that the tax and legal communities are looking at so closely in such an arrangement? First of all, if the manufacturer is unable to service the terms of the lease, difficulties ensue. The lessor will need to repossess the equipment. If however the manufacturer should claim protection from such a move in the courts, there can be problems unless the full and fair market value of the equipment has been reflected in all aspects of the arrangement in the purchase price paid by the lessor initially and in the scale of the lease payments from the manufacturer to the lessor over the lifetime of the lease. From a tax standpoint, careful designations of the terms of the purchase and leaseback are also crucial. The sale transaction must be a complete and legitimate one, not one in which the manufacturer could be construed as simply borrowing capital from the lessor. The validity of the sale-leaseback transaction is also enhanced by the terms set for a potential repurchase of the equipment by the manufacturer. Again the repurchase price must wholly reflect the full market value of the equipment at that time. If it is set too low, there can be inadvertent implications that the manufacturer must purchase back the equipment as part of a loan buyout. The overarching principle is to eliminate any opportunity for the tax or legal community to recharacterize the arrangement as one of borrower/lender, rather than lessee/lessor. The crucial concept that needs to be at work in a sale-leaseback arrangement, therefore, is that the lessor actually has full and complete title to the equipment. Even if never exercised, the lessor must have the unqualified ability to reclaim the equipment and place it elsewhere at any time within legal limits of the lease. Given this situation, a semiconductor manufacturer wanting to pursue a sale-leaseback arrangement as part of a portfolio of financial management techniques related to capital equipment, absolutely must deal with a leasing agent who is legitimate, proven, and endowed with a sound reputation and a customer base of stable, well-run companies. While, good business practices for a semiconductor manufacturer of course suggest partnering with solid business partners, good tax and legal practices mandate such a move. In the case of a sale-leaseback arrangement involving capital equipment valued in the tens or hundreds of millions of dollars, knowing who you're doing business with is an irrefutable obligation. Only the top players in the capital equipment leasing should ever be a consideration as partners in such an arrangement. ***************************** Safety and success L.T. Guttadauro, Executive Director of the newly founded Fab Owners Association, says that being in the semiconductor business requires knowledge and efficiencies in equal measure. He believes that the newly emerging capital equipment leasing options add a great deal to those efficiencies, especially when pursued with a full understanding of the nature and structure of such arrangements. According to L.T., "Leasing is the wave of the future where the semiconductor manufacturer and his equipment vendor join in even a deeper relationship and partnership to manufacture products more efficiently. That's really the byword, we're always looking for efficiencies. It's why the people across the entire industry put themselves out there." The focus for any semiconductor manufacturer these days is to stay ahead of the competition, and that means having access when needed to the best equipment to do the job. (see sidebar below: "Reality Check") With the costs of semiconductor capital equipment skyrocketing, a manufacturer must have access to immense sources of funding and superb financial counsel to sort out the financing options to provide those funds. Clearly, leasing is becoming a critical part of that financing picture and clearly the quality and skillset that your leasing partner and equipment vendor bring to the equation is equally critical to the long-term safety and success of your operations. It's an exciting industry, an exhilarating time, and partnering for safety and success are both the obligation and the opportunity that present themselves to those who choose to participate and to prevail. ***************************** Sidebar - ''Reality Check'' Before looking more closely at the sale-leaseback option, it's good to do a brief reality check on the current semiconductor manufacturing environment. For the top-level IDMs today, of which there are only a handful in the world, these companies have a very high risk factor associated with their business enterprise. When such companies go out and buy a new piece of capital equipment, especially at 90 or 65 nanometers, it's an act of great daring. The costs associated with these machines can run as high as $100 million, but the cutting-edge IDMs have no choice. They have to go down the ITRS roadmap quickly; it's expected of them and defines their burden of leadership to do so. The quest for these IDMs is clear; get expensive, state-of-the art equipment into the facilities and up and running as quickly as possible. The vendors who supply this machinery companies like Applied Materials understand full well the pressures under which the IDMs are working and the equipment vendors appropriately see their role as facilitators in that process. The equipment must be engineered for success and delivered when called for. For both the IDM and the equipment vendor, failure is not an option. Purchasing however, is and as the bulk of this equipment is custom designed expressly for each unique IDM consumers, purchasing is more than an option. It's the opportunity and obligation that comes from doing business at the cutting edge. The landscape within the semiconductor manufacturing industry is nothing, however, if not complex and multi-tiered. Below the rarified atmosphere of the first-tier IDMs, there are various second-tier companies who position themselves as "leading edge" rather than "cutting-edge" semiconductor manufacturers companies like National Semiconductor, LSI Logic, and AMI Semiconductor. These companies are buying equipment, and known technologies, to produce products in the 130 to 90-nanometer range. For these second-tier manufacturers, leasing is quickly becoming an extremely attractive option. These leading-edge companies are not trying to go as fast as their cutting-edge cousins down the ITRS roadmap; these second-tired companies are not as often in need of custom equipment and their business and technical demands are well served by leasing as an avenue to success. Also on the semiconductor manufacturing landscape, there are the "lagging-edge" companies. Though perhaps a less-than dignified way to describe these enterprises terms like "mature" or "traditional" are more conservative the reality is that these companies are meeting the legacy market demand for devices at the 0.2-, .025-, and even 0.35-micron process nodes. These manufacturers are using well-characterized and proven technologies, and they're likely to be found buying, or leasing, and implementing used equipment in their facilities. This class of company often snaps up second-hand equipment when it becomes available because it's inexpensive with a lot of useful life left in the machines. Alternatively, third-tier companies may be leasing equipment from an original owner, or a leasing-agent intermediary because the equipment is not moving and the owners are looking to generate some level of on-going, albeit pedestrian, return on their initial expenditure. Lagging edge or third-tier companies enjoy considerable flexibility. They can use whatever equipment and financing options are most advantageous to the process they're wanting to implement. That latitude is their particular reward for ceding first and second place to others in the competitive world of semiconductor manufacturing. It's important to note that orthogonal to these rough company classifications are a variety of current technical and marketplace issues that articulate the setting within which the companies operate. Technical issues are as varied as the move to new semiconductor substrates, low and high-k materials, the transition to copper interconnects with all of the resultant on-chip crosstalk and parasitic capacitate and inductive affects, new silicon on insulator (SOI) initiatives, and flip-chip and multi-chip packaging techniques that are emerging to meet the voracious demand for highly integrated and complex systems on a chip or chips. And lest we forget, all of this is emerging within the context of hundreds of millions of on-chip transistors. Staggeringly, a billion on-chip transistors are on the horizon. These technical issues are in turn textured by volatile business matter across the industry including the disaggregation and re-aggregation of the semiconductor supply chain, versatile and innovate corporate partnerings along vertical and horizontal axis of core competencies, globalization, outsourcing, and a rate of cross-pollination across business and cultural practices unprecedented in history. The business environment is dynamic; the technical environment is dynamic. In fact, dynamic doesn't begin to sum things up. The business and technical environments are better described as being in a state of barely controlled chaos. The companies that operate within these environments must maintain a nimble and responsive footing if they dare to hope to be in business in ten years, five years, or even in 2006. [Editor΄s Note: The ideas in this Sidebar arose from a fascinating and informative conversation with the very knowledgeable Barbara Kalkis who owns and operates Maestro PR.] ***************************** September 28, 2005 Peggy Aycinena owns and operates EDA Confidential. She can be reached at peggy@aycinena.com |