Jerry Sanders, founder of America’s Advanced Micro Devices (AMD) once called computer chips the “crude oil of industry” and the foundries, which mass-produce them the “smelters of the information age”.
His comments about the power and value of the semiconductor industry resonate very strongly in China, which now finds itself in the unhappy position of spending more on importing computer chips than it does on oil.
But if the past decade was dominated by oil and gas acquisitions, then the coming one looks set to governed by more M&A in the semiconductor industry.
China is determined to move up the value chain and create a domestic ecosystem that can compete head on with global industry leaders such as Qualcomm, Intel, ARM Holdings and TSMC. Since Edward Snowden’s revelations about US phone tapping, it has also wanted to tighten control for security reasons.
As cnstock.com wrote last week, “China is accelerating the localisation process. Chips form the cornerstone of national information security, which means the government will become a very large source of end demand for domestically produced products.”
The government has said all this before. But few doubt the strength of its commitment this time round, particularly as its ambitions are being coordinated by the State Council through a national development programme under vice premier Ma Kai focused on IC (i.e. integrated circuits, another name for a chip).
And the country is already well on the way to meeting its near-term targets, which include increasing China’s market share of the packaging and testing sector to 30% and promoting stronger collaboration between domestic fabless and foundry firms (which design chips and manufacture them).
A recent string of M&A deals may soon culminate in the largest takeover to date – an offer for AMD itself. China’s International Online last month reported that a Chinese consortium including BLX IC (a leading microprocessor designer), SMIC (the country’s largest domestic foundry) and one of China’s new IC venture capital funds would make a bid for AMD.
Should an offer emerge it is likely to be in the region of $3.5 billion based on AMD’s enterprise value (a $2.35 billion market capitalisation and $1.2 billion in net debt). The stock price responded strongly to the rumours, rising 35% between January 20 and February 5, before tailing off slightly.
In recent days, speculation about a buyout offer has been replaced by suggestions the Chinese are preparing to make a series of strategic investments in AMD’s key technologies and product lines. Analysts believe this makes more sense given an outright takeover might prompt American national security concerns and run up against contractual issues with Intel from whom AMD licences chip technology.
Local newspapers now say the investment vehicle will be Loongson Technology, a joint venture between BLX and the Chinese Academy of Sciences. Having failed to develop its own world-beating microprocessing chip over the past decade, Loongson appears to be taking the tried and tested path of trying to buy the intellectual property from overseas instead.
The same strategy holds true in the chip packaging and testing sector where a Chinese consortium has entered into an exclusivity agreement with Singapore’s Temasek to take over STATS ChipPAC. The consortium has put forward a cash bid of $780 million for the world’s fourth largest packaging and testing company, valuing it at $1.5 billion including net debt.
Consortium members include Jiangsu Changjiang (JCET), the world’s sixth largest IC testing and packaging company, SMIC and the state-back IC Industry Investment Fund. (The fund was set up in September last year. Its founders include leading state firms such as China Mobile and the China Development Bank.) During an earnings call earlier this week, SMIC told investors it was putting up $100 million for a 19% stake because it wants to localise its supply chain and support government policy.
Together a merged STATS ChipPAC and JCET would still be the world’s fourth largest packaging and testing company, but in terms of sales, inch far closer to the current numbers two and three (Taiwan’s Siliconware and America’s Amkor).
The merger will also expand China’s market share, which had already risen from 15% to 25% between 2010 and 2013. Were the deal to go through it would add a further 6%, taking China over its 30% target. Analysts say neither company currently generates free cashflow, so the merged entity will need heavy government support to fund the capex needed to increase its market share further.
And this is likely to be forthcoming thanks to the firepower of the IC Industry Investment Fund, which is believed to have raised about Rmb100 billion ($16 billion) by the end of last year. A further Rmb40 billion fundraising round is expected during the first quarter.
McKinsey has estimated China will spend up to Rmb1 trillion over the next decade to break its dependence on foreign chip suppliers and create the national champions it has long desired. The new IC fund is likely to be at the forefront.
One of the first beneficiaries will be SMIC, which has attempted (not entirely successfully) to break the Taiwanese duopoly held by TSMC and UMC over the past 15 years. The domestic foundry is receiving $300 million in a new bid to push it further up the technology curve.
Since last summer its efforts to develop 28nm wafer technology have been aided by smartphone chip manufacturer Qualcomm, which hoped its collaboration would spare it from having to pay punitive damages from an ongoing antitrust probe. This has not proved to be the case, with the company fined $975 million earlier this week and more importantly, told to reduce the royalty payments it receives from Chinese manufacturers (WiC will examine Qualcomm’s problems more deeply in next week’s issue).
Other Chinese firms may also benefit from a series of regional IC funds, which are being set up. The city of Beijing has raised Rmb30 billion so far and Shanghai has also pulled in Rmb10 billion. Similar funds are being set up in Wuhan and Hefei.
Hua Capital is managing one of Beijing’s sub funds and last August submitted a $1.7 billion non-binding bid for Nasdaq-listed OmniVision, which makes image sensors for smartphone cameras. Its bidding partner is Shanghai Pudong Science and Technology, which also made a bid for China’s third largest mobile chip designer RDA Microelectronics, but found itself up against Tsinghua Unigroup – highlighting the potential pitfalls of different pools of money competing against each other. Tsinghua Unigroup has rapidly emerged as a dominant player in the fabless semiconductor sector after successfully bidding $910 million for RDA, as well as spending $1.78 billion for Chinese chip designer Spreadtrum.
Together they have the potential to become a formidable competitor to Qualcomm and Taiwan’s MediaTek, potentially lowering their rivals’ margins when Spreadtrum launches its 4G chip products later this year. CEO Leo Li recently told cnstock.com how the established players have been trying to maintain their stranglehold. MediaTek, he said, threatened to terminate its agreements with electronics manufacturer TCL after discovering it had been talking to Spreadtrum.
Intel, however, has taken a different tack. Keen to diversify from PCs to mobile phones and tablets, it has decided to cooperate with China’s efforts to move up the value chain and made a number of investments, including the purchase of a 20% stake in Tsinghua Unigroup for $1.5 billion.
Spreadtrum and Intel are now using Intel’s architecture to develop a system-on-chip, which integrates all of a computer’s components onto a single chip. These super chips will likely be manufactured at Intel’s new foundry in Dalian, offering SMIC strong competition from a domestically-located rival for the first time.
iSuppli analyst Gu Wenjun tells cnstock.com that China’s time has come. “Over the past 30 years the semiconductor industry has suffered a number of cyclical downturns, which have enabled Asian countries from Japan to South Korea and Taiwan to benefit,” he concludes. “Now it’s China’s turn to seize the moment and grab the opportunities in front of it.”
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