The market is underestimating one corner of artificial intelligence, according to Morgan Stanley. That’s advanced packaging in semiconductors, which consists of technologies that package integrated circuits to “increase functionality, high performance and form the foundation for more powerful and more efficient AI chips” — the last step in semiconductor manufacturing, after design and fabrication, the bank explained. It’s the process of packaging fabricated chips to protect them and enable them to connect to external devices, it added. The innovation in the sector is set to drive AI chip capabilities, said Morgan Stanley. It said packaging is a “critical means” of increasing processing power as AI becomes more widespread. “Unlike traditional electronics packaging for PCs or smartphones, today’s AI systems require [graphics processing units], CPUs, high-bandwidth memory (HBM), I/O controllers, and other components to relay information at blazing speeds and as energy-efficiently as possible,” the bank’s analysts wrote. “Previously considered ‘back-end’ and as a cost center, packaging is now the primary way to improve performance as manufacturers struggle to scale geometry profitably,” they said. “Engineers have realized that they can utilize all parts of a chip, including the packaging, to increase performance.” Morgan Stanley predicts the market in advanced packaging will be worth $116 billion by 2027, calling it an “upgrade supercycle,” fueled by AI’s “insatiable demand for computing power, memory, and even new chip architectures.” “We think the market underestimates both the pace of innovation and the implications for growth,” the bank said. Morgan Stanley says it sees “outsized winners” in Japan, South Korea and the European Union. It named stocks to play the advanced packaging trend, adding that they fall into one of two categories: tech companies at the forefront of AI computing and those benefiting from packaging supply chains. Here’s what the bank says about some of its picks. United States Amkor : The firm is set to be “uniquely positioned” to benefit from the Outsourced Semiconductor Assembly and Test Services industry (OSAT), which is at a “transformational moment,” Morgan Stanley said. The bank noted the company has plans to build an advanced packaging and testing facility in Arizona – which will then package and test chips produced for Apple at the nearby TSMC facility. “Amkor intends to build out more than 500,000sf of clean room space with manufacturing targeted to be ready for production within the next 2-3 years,” said Morgan Stanley, referring to a type of highly controlled environment to make semiconductors. “This would position Amkor as an enabler of domestic end-to-end leading edge production.” ACM Research : The bank noted that SK Hynix, the world’s second-largest maker of memory chips, is a key client for ACM Research. It says there may be upside for ACM’s business if it’s able to ship copper plating and advanced packaging products for SK Hynix’s high-bandwidth memory production line. It predicts that will happen when SK Hynix’s HBM4 product is launched. It started producing HBM3E earlier this year. Taiwan TSMC : Morgan Stanley noted the Taiwanese semiconductor firm is a major provider of CoWoS technology, a type of packaging technology. It pointed out that 6%-7% of TSMC’s total 2023 revenue was from advanced packaging and testing. But Morgan Stanley predicted that would exceed 10% in 2024 with the firm’s capacity in this technology set to more than double this year. “TSMC continues to develop different variants of advanced packaging technologies for customers’ different demands,” the bank added. AP Memory: Memory bandwidth and power consumption are essential for AI computing, and this firm’s packaging technology could be the “effective” solution to provide that because it can achieve 10 times the memory bandwidth and 90% power reduction of the HBM2E technology, a high-bandwidth memory technology. Japan Morgan Stanley says it favors Disco and Advantest the most out of all the companies in Japan that are producing equipment for advanced packaging. It says that Disco is adopting a strategy that will keep it as a “high-profit company” by providing “appropriate solutions” ahead of other companies. Advantest is likely to benefit from “strong growth” in the advanced package tester market through this decade, it added. — CNBC’s Michael Bloom contributed to this report.