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Chinese chipmakers still struggling, despite stockmarket fanfare

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A lot has changed since China’s chip manufacturing giant, SMIC (Semiconductor Manufacturing International Corp) completed its dual listing on the Hong Kong and New York stock exchanges in March 2004. For starters, the sophistication of the technology used to manufacture semiconductor chips has accelerated exponentially over the past 16 years, as it always does in the tech sector.

Back then the industry’s cutting edge technology was 130 nanometres (nm), with global industry leader TSMC starting to transition to 90nm. The most advanced chip using that type of technology had about 112 million transistors on it. Examples included Intel’s Pentium 4 computer processor.

Today, 7nm is the leading edge technology, with 5nm on the horizon. This advancement enabled TSMC to cram eight billion transistors onto Huawei’s self-designed Kirin 990 chip, which powered the Mate 30 Pro smartphone launched last December.

Back in 2004, few people thought that China would be capable of fostering a leading chip design house like Huawei’s HiSilicon unit anytime soon. But many did think that a company like SMIC, which manufactures chips to others’ designs (known in industry parlance as foundries or fabs), might be able to catch up with TSMC. They are still waiting.

Analysts estimate that SMIC is still about five years behind its Taiwanese rival: a sizeable gulf given how fast the tech sector evolves. International investors are well aware that SMIC has continuously been ‘lagging’ edge rather than leading edge as well. Consequently, they didn’t traditionally accord it a valuation premium.

This reason, alongside geopolitics, is why SMIC decided to delist from the New York Stock Exchange (NYSE) in June. Instead, it is returning home to great fanfare: something else that would have been unthinkable back in 2004.

Its planned Rmb20 billion ($2.8 billion) flotation on Shanghai’s one-year old STAR technology board is not only likely to be extremely successful, but will also establish the new Chinese record for the shortest timeline between an application and a listing. Public subscription opens next week.

Another company that has received speedy approvals is artificial intelligence (AI) chip designer, Cambricon. The Alibaba-invested tech firm is preparing to raise Rmb2.8 billion through its IPO. Unlike SMIC, it is a four-year old start-up and remains unprofitable.

Cambricon is in danger of being overshadowed by SMIC, especially if recent share price movements in Hong Kong are anything to go by. So far this year, China’s army of retail investors have pushed SMIC’s stock up 213%, buying through the city’s Stock Connect scheme. As a result, SMIC is now trading at a very punchy 75 times its forecast 2020 earnings. This is an exceptionally high premium over TSMC, which trades at 23.7 times.

Retail investors clearly believe that SMIC will rapidly move up the industry value chain, backed by substantial sums of government money. Earlier this year, for example, the company received $2.25 billion towards the cost of a new foundry from the state-owned China National Integrated Circuit Industry Investment Fund, which invests in the semiconductor industry. The same fund also owns 24% of telecommunications equipment company, ZTE.

Shenzhen and Hong Kong-listed ZTE also prompted an investor frenzy two weeks ago. This followed a misinterpretation of management comments by a host of domestic media outlets.

ZTE had said that it had started mass production at 7nm for chips being deployed in its 5G base station equipment. It also said it was working on a more advanced chip using 5nm.

Many thought this meant that ZTE had mastered 5nm production technology, as well as a more advanced chip design process. Its share price correspondingly rose 22% on June 18 in Hong Kong.

The company issued a clarification the following Monday, explaining that it was sourcing the chips from elsewhere. Its share price retreated again.

The whole episode demonstrates the hopes and fears wrapped up in China’s quest for technological independence. But ZTE’s sourcing news also surprised some analysts, who thought that it had used Intel’s Atom P5900 chips for its 5G base station equipment. This is the same chip that Ericsson and Nokia are using and which Intel is manufacturing at 10nm production nodes, not 7nm.

Huawei, on the other hand, has designed its own 7nm 5G base station chip (the Huawei Tiangang), which TSMC was lined up to produce.

ZTE could place an order with TSMC or Samsung Electronics for its future chips, as they are the only two foundries that operate at 7nm. However, recent developments in the Sino-US trade and tech war suggest that the American government will not want to see ZTE win international orders for 5G telecommunications equipment anymore than it wants Huawei to.

On May 15, the Trump administration announced new export controls designed to stop Huawei benefitting from chip production based on US technology. Shortly afterwards, TSMC said that it had stopped taking orders from the company, although some news outlets report that Huawei had managed to stockpile two years worth of base station and smartphone chips.

ZTE currently has a US compliance official working inside the company to ensure that it does not contravene the terms of a 2018 agreement relating to sanctions breaches (when it sold telecommunications equipment to Iran and North Korea). It feels like ZTE is never more than a few steps away from being subject to the same ban as Huawei.

One company that neither ZTE nor Huawei will be able to turn to for advanced chips is SMIC. The latter has only just entered commercial production at 14nm nodes and it is not clear why the domestic media believes it will be upgrading to 7nm in the fourth quarter.

So far, the US government has also been able to hamstring SMIC’s ability to climb the technology curve faster. As we reported in WiC480, Washington managed to persuade the Dutch authorities to refuse SMIC a licence agreement for one of ASML’s EUV (extreme ultraviolet lithography) machines in 2019.

Without it, SMIC cannot upgrade to 7nm and there is nowhere else it can buy the same machines from. Almost half of SMIC’s production equipment also relies on US technology in some form or other. This means that the Trump administration could quickly hobble SMIC, should it start to manufacture advanced chips for Huawei.

Other key equipment includes EDA (Electronic Design Automation) software. The only suppliers are American (Synopsis and Cadence), or companies that have a US headquarters (Siemens-owned Mentor Graphics).

This does not mean that SMIC cannot become more profitable. It is almost certain that more and more Chinese companies will use it to produce computer chips. Indeed, its first quarter revenues were up 35.3% to $904.5 million.

However, this will not help the Chinese to achieve the desired self-sufficiency at the more advanced end of the chip manufacturing spectrum anymore easily in 2020 than in 2004. If anything, the hurdles are even greater now. The US is determined to stop Chinese companies getting hold of the missing pieces of the semiconductor puzzle and then reverse engineering them to achieve technological equivalence.

As for Huawei, it had been planning to use TSMC to produce the Kirin 1100 chip, which will be used in its Mate 50 smartphones, scheduled for launch in 2021. That will require 5nm production nodes.

Huawei is reportedly trying to forge an agreement with Samsung for advanced base station and smartphone chips. However, Samsung also uses US equipment in its production processes and the South Korean government is a key military ally.

As we have reported before, Washington has put all of its allies under immense pressure to keep Huawei out of their 5G networks on security grounds. Many countries must also be wondering whether Huawei can still fulfil orders now that its production has been blocked off too. The latest to opt for alternative suppliers is Singapore. This week it finalised its 5G vendors: Ericsson and Nokia.


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