Cover Story: Hello, Mr. Chips –

For almost 50 years venture capital and the semiconductor industry have been intimately linked. The stories of how the two have evolved together are the stuff of legend. How a letter from Eugene Kleiner found its way to the desk of Arthur Rock and led to the founding of Fairchild Semiconductor. How Jerry Sanders convinced Steven Merrill, who had never invested in semiconductors, to help fund the startup of AMD.

The stories continue to be written. If we had to predict who would be the central character 20 years from now, we’d put our money on Lip-Bu Tan, chairman and founder of Walden International, someone we’ve taken to calling “Mr. Chips.”

With 12 chip investments made between November 2003 and January 2005, Tan and his colleagues at Walden outpaced the likes of Intel Capital, 3i and JPMorgan Partners. And, Tan tells us, Walden is betting exclusively on semiconductors (and China) for the foreseeable future. It is one of the boldest statements by a venture capitalist that we can think of, but not the only one Tan made in a wide-ranging interview.

Q More than $3 billion went into chip investments in 2004, considerably more than 2003, and well above 2002 and 2003. Why?

A The founders of semiconductor startups are creating opportunities that make people want to invest. For a long time it was just handsets that were driving the market. Now there are startups in digital TV, home-gateways through set top boxes, projector televisions, communications such as WiMax and all of the consumer wireless space.

Was too much money invested in semiconductors in 2004?

Yes and no. There was a lot of money in a few areas that were over-funded and some areas where there was not enough.

Which areas have been over-funded/under-funded from among the sub-sectors fabless (including imaging and communications), design and manufacturing, memory, processors or novel technologies, and sensors?

Well, money that VCs put into process technologies is hard to imagine as successful. The IDMs [independent device manufacturers] have to do that investing. Memory, well there are some opportunities, but not a lot. Samsung is dominant there and there are only a few niches, like low power or high speed. In imaging there are some opportunities, making sensors from CMOS instead of using CCDs. Very high-resolution displays has some niches for investing. Design for manufacturing has opportunities as geometries are shrinking.

Which sub-sectors are overcrowded, most prone to failure by investors?

Process engineering. And within fabless models, WiFi, storage [processors] security, graphics and MP3.

Which of the sub-sectors still has room to invest?

It’s not that simple. This is a $200 billion per annum industry. But in 2005 it’s going to be flat. There is maybe 10% growth in the industry over the next five years and at the same time prices [for semiconductor devices] are declining. So there are not lots of growth opportunities. So if you want to invest, you have to go to areas where there are big technical problems to solve or areas where you want to be over the long term, like power devices and advanced technology like processors.

Which of the sub-sectors shows the most promise and why?

There are so many. Take any one, say automotive. There are so many uses of semiconductors today in a car: imaging, sensors, GPRS [general packet radio service], entertainment, transmissions. That one area presents a huge set of opportunities over the next five years, and there aren’t many investors there yet.