Talking Point

The heart of the matter

SMIC’s delisting in New York is yet another milestone in the Sino-US tech war

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Multinational look: flags outside an SMIC plant showcase some of its overseas shareholders

The Chinese name of SMIC is Zhongxin Guoji. The first two Chinese characters are a pun on ‘China’s heart’ while the latter two mean ‘international”. The name sums up the patriotic mission that the state-backed foundry has struggled with for two decades: how to crack overseas dominance of the global semiconductor industry.

When SMIC was building its first foundry in 2001, the $2 billion fab risked becoming a white elephant unless it could secure approvals from the United States to purchase an older generation of 0.18-micron processing technology. One crucial factor for SMIC getting the nod was its diversified shareholding structure. Alongside various Chinese government entities, SMIC’s major investors included financial institutions from the US, Taiwan and Singapore. The biggest shareholder, Shanghai Industrial, backed by the Shanghai government, only owned a 12% stake. This made SMIC look more “international” and less vulnerable to state intervention than some of the other giant SOEs.

However, its shareholder makeup also left SMIC vulnerable to internal feuds over how the chipmaker should be run. As Taiwan’s Business Weekly has reported, SMIC has often seemed torn between pursuing commercial profit (a goal prioritised by the “international team” of shareholders) and investing heavily in newer generation fab technology (something the “national team” prefers).

That dichotomy has dogged its growth and stemmed its ambitions to unseat Taiwan’s TSMC as the world’s largest semiconductor manufacturing firm.

But has SMIC finally settled this internal struggle after it announced its decision to delist from the New York Stock Exchange (NYSE) last week? Is state diktat finally prevailing at China’s biggest chipmaker? And what does that mean for the trade and tech spats between Beijing and Washington?

What is SMIC’s delisting plan?

SMIC went public in Hong Kong and New York in 2004. In a circular published last Friday, it said it had applied to delist its American depositary receipts (ADRs).

SMIC’s last New York trading day will be around June 13 – although trading of its US securities will still be available at the over-the-counter bourse, the statement said.

As of this week, SMIC’s market value was close to $6 billion, although the share price of its ADRs had dropped to below $6 from a peak of over $15 in 2004.

The decision to end its 15-year stint on the NYSE, SMIC executives told Chinese media, was because its ADRs had been so thinly traded – average daily turnover was no more than a tenth of the volumes traded in Hong Kong, for instance. As a result SMIC management concluded that the administrative burdens of maintaining a listing in New York weren’t worthwhile – particularly as it had not proven a very lucrative means of fundraising.

SMIC insists that the timing of the announcement was coincidental, telling CNBC that “it has nothing to do with the trade war and the Huawei incident”, referring to Washington’s decision to put the Chinese telecom giant on an export blacklist this month (see WiC453).

A slew of Chinese tech firms have been taken private from US bourses in recent years – often in response to fading interest from American investors in their shares. Some of them have relisted on China’s A-share market where they have received much higher valuations.

Switching from the world’s biggest financial centre to China’s A-share market is likely to lessen SMIC’s appeal to many international investors. Yet the relocation could also raise much-needed funds for the chipmaker to expand its R&D capabilities. Should more state-backed investors want to back the semiconductor firm, it might even offer a profitable opportunity for SMIC’s foreign shareholders to exit.

How ‘international’ was SMIC?

The Chinese government had invested heavily in a number of state-backed foundries in the 1990s but they all faltered because of export restrictions imposed by the Wassenaar Arrangement (WA), a multinational pact set up in 1996 to limit dissemination of technology that could have military use. Even in the post-Cold War era, chips are high on the WA’s control list and China is one the countries that elicits closer scrutiny from the US-led grouping.

Beijing began to change tack in 1999 and tried to make its foundries look less government-directed. One way to do that was to engage with investors from Taiwan’s booming semiconductor sector.

An example was Winston Wang, son of Taiwan’s most famous tycoon Wang Yung-ching, who founded Formosa Plastics. Wang junior in turn established Grace Semiconductor Manufacturing Corp (named after his daughter) on the mainland in 2000. But this cross-Strait joint venture soon soured because of the WA’s sale restrictions. One key sticking point: the Chinese government was deemed too influential at GSMC. Wang’s mainland partner, according to the Financial Times, was Jiang Mianheng, the son of former Chinese leader Jiang Zemin.

Founded the same year, SMIC was able to skirt the WA’s export controls (at least for less-advanced technologies – for instance, the 65-nanometre technology it purchased in 2005 was at least two generations behind the kit that leading American firms were using at the time) and this owed much to its founder Richard Chang.

A veteran of Texas Instruments (TI), Chang brought overseas experience and an ability to build relationships with SMIC’s international partners. A Taiwan-born American and a devoted Christian, Chang even pledged to five American Christian groups that he would never transfer US technologies to China for military usages, Sohu Finance reports. He also made sure to keep in contact with the 16 key shareholders in the investor base, which included the likes of Goldman Sachs and Walden International from the US, Taiwan’s private equity group H&Q Asia Pacific, and Vertex Venture, a unit of Singapore’s Temasek.

A tale of two Changs…

Born in 1948, Richard Chang isn’t related to Morris Chang, the founder of TSMC, who retired last year (see WiC407). But both men worked for many years at Texas Instruments, however. While Morris, 17 years older, left TI and founded TSMC in 1987, the younger Chang stayed on for longer before joining TSMC’s local rival WSMC in 1997. He was soon promoted to general manager. But against his advice, the foundry’s biggest shareholder (Taiwan’s China Development Bank) agreed a $5 billion takeover proposal by TSMC in January 2000.

Chang refused to work for the older Taiwanese tech tycoon – but he was not short of job offers in mainland China, where the government was desperate to build more foundries. Following the sale of WSMC, Chang got the necessary support to found SMIC and opened its first foundries at a rapid pace, poaching executives and engineers from TSMC to join his Shanghai-based venture.

In doing so, he angered the government in Taipei, which later slapped a hefty fine on him for “illegal investment”, as well as making more of an enemy of TSMC’s Morris Chang.

TSMC began a prolonged legal battle in the US against SMIC in 2003 on claims relating to technology theft and patent infringement. The wrangle went on for years until 2009, when SMIC conceded defeat. The settlement was costly: on top of a $200 million cash compensation payment SMIC was also required to sell a 10% stake in itself to its bitterest rival. As an unwritten condition, Richard Chang then resigned as company CEO.

His ousting and the arrival of TSMC as its second biggest shareholder complicated matters behind the scenes at SMIC, as it struggled to balance the interests of the Chinese state and its overseas investors.

A costly tussle?

“Line struggle” is a political term for a situation when feuding factions of the Chinese Communist Party take separate sides to sort out their ideological differences.

For SMIC, it refers to the two vastly varying visions held by shareholders. The “international team”, mainly private equity firms looking for financial gain, have wanted SMIC to focus more on turning a profit. The “national team” stresses SMIC’s strategic role in bringing more advanced chipmaking know-how to China.

These are two uncompromising “lines”, Sohu Finance says. For its first nine years SMIC was consistently lossmaking. However, its strategy did help to reduce some of the gap in capabilities between China’s semiconductor firms and the operations of more established, overseas chipmakers.

The rift between shareholders grew wider when SMIC sold a 16.6% stake to Datang Telecom, a state-controlled telecom equipment maker. The move came after its market value plunged more than 70% during the global financial crisis and the overseas shareholders were enraged by the $175 million deal: it valued SMIC at just $1 billion, compared with its $16 billion peak when it listed in 2004.

When he was boss Chang usually played the role of middleman, trying to balance the interests of the feuding parties. But his ousting meant that these boardroom squabbles began to boil over, especially when the overseas shareholders opposed potential mergers that Datang proposed (see WiC116).

The introduction of a co-CEO system in 2017 has been another attempt to maintain the balancing act. But the effort seems to be unravelling, with the Financial Times reporting last month that co-CEO Zhao Haijun is said to be considering quitting because policymakers in Beijing are prioritising the work of his counterpart Liang Mong-song in developing more advanced chip production at 14-nanometre resolution and beyond – sacrificing near term profits.

“The upheaval indicates that in China’s current programme for creating a domestic chip manufacturing base, state diktat is gaining the upper hand over commercial objectives,” the FT wrote.

Mind the (very large) gap…

SMIC’s struggles illustrate that mainland China’s largest foundry – as well as the country’s semiconductor industry as a whole – still lag behind their international rivals.

According to its first quarterly report in 2019, SMIC’s production lines for 28-nanometre nodes only accounted for 3% of its revenues and it had only just begun to push into 14-nanometre technologies. Instead the bulk of its revenues are still coming from the lower stratas of the chipmaking market in 45 nanometre nodes and in areas like assembling.

Conversely the most advanced 7-nanometre technologies contributed 22% of TSMC’s first quarter sales.

“SMIC can’t even see the rear lights of TSMC,” Taiwan’s Liberal Times crowed last month.

The gap is even bigger further upstream, where American firms such as Qualcomm and Intel defend the lion’s share of the chip design market. A slide presented to scholars at a Chinese tech conference last year – and which still enjoys viral status in social media – showed the projected market shares of locally designed CPUs in 15 major electronic products with nearly all of them showing a zero percentage for Chinese content.

The drawbacks of this reliance on foreign tech were exposed last year when Donald Trump’s administration crippled state-backed telecoms equipment maker ZTE with a ban on US component sales. And all eyes are now on Huawei and how resilient it will prove after being put on an even more stringent export blacklist a fortnight ago.

Ni Guangnan, a leading scientist at the Chinese Academy of Engineering, told a tech conference in Guiyang this week that China is now putting “an entire country’s effort” into weaning the economy off its reliance on foreign semiconductor imports (according to the China Semiconductor Industry Association, China imported $260 billion worth of semiconductors in 2017).

Besides strong state support, Ni also noted that many private sector tech firms such as internet behemoth Alibaba are rallying to the cause of accelerating the development of China’s own chips.

SMIC is set to be a key plank in the catch-up campaign, which has been described by some media outlets as the “new Great Leap Forward” (a very unfortunate comparison considering an estimated 45 million Chinese starved to death in the famine triggered by the original Great Leap Forward’s disastrous effort to catch up with the UK in steel production in the late fifties, according to historian Frank Dikotter).

Of course, the costs of catching up are going to be enormous: TSMC, for example, has already committed to spending $25 billion on building new cutting-edge 5-nanometre fabs, technology that is at least three generations ahead of SMIC’s.

Almost ironically, while SMIC appears to be turning more “Chinese” in its corporate priorities, some observers have suggested that Huawei could pacify some of its overseas critics by adopting a more global ownership structure – akin to SMIC in it earliest days.

“The time is ripe for Huawei to launch an IPO and to address political and security concerns once and for all,” urged Andrew Foster and Nicholas Borst, chief investment officer and director of China research at Seafarer Capital. Their op-ed in the South China Morning Post this week proposed that Huawei could even invite a former senior US government official to become a board member as a strategy to enhance its credibility.

How likely is that? Not very, WiC reckons. Indeed Huawei’s founder Ren Zhengfei may feel that the history of SMIC is a case of ‘been there done that’ – and he may conclude that it didn’t work out too well for another founder: Richard Chang.


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