Licence to kill

After a drawn-out trade war, the rise of a tech firm from the world’s second largest economy posed a new threat to American leadership in core technologies.

The challenger had emerged as a pacesetter in the consumer electronics market and it was threatening American primacy in the semiconductor sector as well.

It’s a story that the Chinese media has been retelling in recent months, noting how Washington resorted to unprecedented sanctions against the foreign firm, including hefty fines, import tariffs and restrictions on sales of some components. The plot sounds familiar but the company in question was Japan’s Toshiba. The year was 1987.

At the height of the row, Toshiba Machinery, a unit of the Japanese electronics giant, was accused of selling technology to the Soviet Union that would help Russian submarines to sail as silently as American ones. Two executives ended up resigning and Toshiba printed a full-page apology in 91 newspapers in the United States. More importantly, it agreed to share more of its R&D with American partners.

The saga is said to have marked the beginning of Toshiba’s decline in the global electronics market and the subtext of the story in the Chinese media is crystal clear: that Huawei is now getting much of the same treatment as Toshiba.

Another round of measures making life even more difficult for the 5G giant has simply underlined the point this month, keeping it at the heart of the Sino-US tech war.

What are the latest American sanctions?

When the Bureau of Industry and Security (BIS), an agency under the US Department of Commerce, put Huawei and its overseas subsidiaries on an Entity List last May, the directive was clear. Any US firm wanting to sell American tech components or software to Huawei needed a licence from the US government.

In a company presentation a few weeks later Huawei executives put up a photo of a fighter plane being hit by gunfire.

Huawei was taking heavy flak from its opponents in the United States, they said, but it was still in flight.

But on the same day that the extension of the Entity List restrictions were announced last week, the BIS dropped another bombshell. Overseas companies supplying semiconductor chips to Huawei will now have to apply for a licence from the Commerce Department too, if their production process derives any assistance from American technology.

The implication is that licences aren’t going to be approved, even if an application is made.

And so this week the fighter plane analogy was back at Huawei HQ, when Guo Ping, one of its three rotating chairmen, again compared the company to an aircraft riddled with bullet holes.

“Over the past year, patching up the holes was our priority. We will now work hard to figure out how to survive. Survival is the keyword for us now,” he told attendees at a conference in Shenzhen.

Why is Washington upping the ante?

The Covid-19 pandemic has already strained Sino-US relations to the point that people are talking about a new Cold War (see WiC495). But in the context of the embargo on component sales, Donald Trump’s administration has been frustrated at how Huawei has found ways around the restrictions. The new rules are an attempt to squeeze supply to the point of suffocation.

“There has been a very highly technical loophole through which Huawei has been able in effect to use US technology with foreign fab producers,” Commerce Secretary Wilbur Ross told Fox Business, predicting that the changes would have “a very powerful impact” on Huawei’s sourcing of new product.

Which semiconductor firms will be most affected?

About 40% of the world’s chipmakers depend on American hardware, the Financial Times estimated this week, with an even greater proportion relying on American software in their production processes.

One of the main tactics that Huawei has deployed to dodge the restrictions is to use chips designed by its semiconductor subsidiary HiSilicon. However, most of these have been made by Taiwan Semiconductor Manufacturing Company (TSMC), which now counts Huawei as its second-largest customer after Apple.

Nikkei Asian Review has reported this week that TSMC will now stop sales to Huawei because of the new sanctions, although the Taiwanese foundry put out a statement saying it was studying the new restrictions with its legal advisers.

In the same week that independence-leaning Tsai Ing-wen started her second presidential term in Taiwan, local media explained that the new embargo is tailor-made to curtail Huawei’s contracts with TSMC.

The subplot, according to Commonwealth Magazine, is Washington’s new resolve to kill off the Chinese firm before it embeds itself in more of the world’s 5G network. “The BIS has never explained very clearly how its Entity List works,” the magazine remarked. “But it is effectively a warning to everyone on the sidelines not to help Huawei…”

TSMC: coming to America?

Just hours before the announcement from the US Commerce Department, TSMC sent shockwaves through the sector with news of its own: it plans to invest up to $12 billion in a new 5-nanometre (nm) semiconductor plant in Arizona.

This new fab will be one of only two of its kind, capable of producing the world’s most advanced chips (the other is in Taiwan).

Arizona is already a major hub for electronics, aerospace and defence firms, as well as home to a cluster of integrated-circuit (IC) producers such as Intel and Honeywell. However, TSMC needed to be persuaded to make the move and as recently as April, its chairman Mark Liu was talking about a “cost gap” in shifting more of its production to the US.

In Taiwan, TSMC is surrounded by a specialised supply chain that makes its operations more cost efficient, although Digitimes, a specialist electronics news site in Taiwan, says that the decision could trigger others to make a similar move, including key local partners such as Chipbond and ASE Tech.

Naysayers are pointing more to the experience of Foxconn, the largest assembler of Apple products. Great things were expected when it announced a plan to build a $10 billion plant in Wisconsin (see WiC440), with a commitment to create 13,000 jobs amid promises of substantial subsidies from the federal and state governments to help the factory get going.

But progress has been limited and the Taiwanese firm has invested very little so far – so little, in fact, that it no longer qualifies for many of the subsidies that were promised.

The timing of the announcement about TSMC’s new plant in Arizona was also curious, although the Department of Commerce has denied any connection to the tightening of restrictions on sales to Huawei.

TSMC says the same.

Of course, it’s tempting to see the relocation as part of a broader strategy at play. But analysts say that the fab in Arizona won’t do much to tilt the balance of semiconductor manufacturing back towards production in the US.

The factory expects to produce 20,000 wafers a month once it opens – a small fraction of the 12 million wafers that TSMC made last year. And by the time that it opens, the chips it produces aren’t likely to be the most cutting-edge either.

All the same, industry insiders are wondering if some kind of deal might still be struck that sees Washington ease up on the export restrictions by giving TSMC a licence to make lower-powered chips for Huawei’s consumer devices like handsets. This would lay the basis for a limited deal with the Taiwanese chip manufacturer. However, the same approvals wouldn’t apply for higher-performing processors used in the production of Huawei’s servers and networks, or in applications in areas like AI. Here, the Americans would insist that the embargo is enforced.

How will Huawei source its semiconductors if TSMC turns away?

Huawei is believed to have been stockpiling chip orders for some time on the expectation that the export ban was going to be tightened. Commentators say that there are other ways that some of the semiconductor firms might attempt to wriggle out of the restrictions. The industry supply chain is so extended that some might claim that they didn’t know that Huawei was the final customer for their goods, for instance.

In the past Huawei has also talked about shifting more of its orders for advanced chips to Samsung. How that would work remains unclear as the South Korean firm uses some of the same US technology that TSMC does. Samsung would also be reluctant to sully its reputation in Washington by continuing to supply the Chinese firm.

In the meantime Huawei will accelerate its efforts to become more domestically focused in its production capacity. A month after the BIS unveiled its initial ban on Huawei last summer, Nikkei Asian Review reported that a teardown of a Huawei P30 Pro handset showed that the Chinese firm would need to find non-US suppliers for 15 of the highest value parts of its newest smartphone. A similar test was conducted this month on the Mate 30, Huawei’s new flagship model. It found that parts from China now accounted for 42% of the total, up from 25% a year ago.

Huawei’s R&D spend in 2019 also jumped nearly 30% to Rmb132 billion ($18.6 billion), with a large chunk of the capital flowing to HiSilicon, the company’s chip designer. However, even HiSilicon relies heavily on American software to design its own chips. And there is no fab in China capable of producing chips at the advanced nodes Huawei requires for its most sophisticated mobile phones and telecoms equipment.

The longer term plan is for SMIC to emerge as the domestic champion in the sector, reducing the need to buy semiconductors from overseas. The Shanghai-based fab, a long-term rival of TSMC, announced this week that it had received a further $2.2 billion in investment from two state-backed funds.

All the same, it is still some distance behind TSMC in technical know-how. It has only just started commercial production of 14nm nodes. It also needs US tooling and materials to operate, which means it is subject to the same restrictions from Washington as TSMC. It can expect to be sanctioned should it ignore the directives on sales to Huawei, and thus lose access to the equipment it needs to grow its own capacity.

How might Beijing fight back?

The next question is how the Chinese government could choose to retaliate to the export restrictions announced last week.

A military metaphor has been widely referenced on a WeChat blog post: the Battle of Shangganling (or the Battle of Triangle Hill, one of the bloodiest confrontations of the Korean War in the 1950s). For the Chinese the battle is a symbol of how the indomitable spirit can prevail over superior military force. But the article also notes that Huawei needs support from its own government in fighting back against the might of the American state.

Beijing has threatened a retaliatory blacklist of its own for almost a year and an obvious tactic would be to make life more difficult for US companies such as Qualcomm in the Chinese market.

The Global Times is already salivating about a more aggressive approach, describing it as the “nuclear bomb” strategy. “China will launch rounds of endless investigations into those firms, just like swords hanging over their head. It will dampen investors’ confidence and squeeze their income in the Chinese market,” an anonymous source told the newspaper.

A significant aspect of the latest attack on Huawei is what it says about America’s willingness to unleash forces it had hitherto held back from using, given its past role as globalisation’s creator and defender. Washington has already weaponised the dollar (against Iran, for instance). The latest decision has weaponised the semiconductor supply chain.

If this does become a tech equivalent of the Battle of Shangganling – which the Chinese argue they won after American and UN forces retreated from their strategic objective (Triangle Hill) after mounting troop losses brought about by a fanatical defence by a military that was less concerned about casualties – then what is China’s option for weaponising its own supply chain? A ban on all TSMC-made chips coming in to mainland China would fit with the Shangganling mentality (i.e. a willingness to inflict as well as take pain). Not only would it punish TSMC for bowing to US policy (cratering its sales) it would also cripple Apple’s production lines, the bulk of which remain in China. The cost to China – colossal job losses in impacted factories – would be huge too…

---

© ChinTell Ltd. All rights reserved.

Sponsored by HSBC.

The Week in China website and the weekly magazine publications are owned and maintained by ChinTell Limited, Hong Kong. Neither HSBC nor any member of the HSBC group of companies ("HSBC") endorses the contents and/or is involved in selecting, creating or editing the contents of the Week in China website or the Week in China magazine. The views expressed in these publications are solely the views of ChinTell Limited and do not necessarily reflect the views or investment ideas of HSBC. No responsibility will therefore be assumed by HSBC for the contents of these publications or for the errors or omissions therein.