In 1933, one of the most lauded stock pickers of all time declared that “the four most costly words in the annals of investment” are “this time it’s different”. John Templeton, who went on to found the Templeton Growth Fund, concluded that investors are always seeing the “repeat of an earlier situation”.
That’s certainly been the case throughout the history of the semiconductor industry. Over the past few decades, equity market investors have found it all too easy to be on the wrong side of some pretty spectacular peaks and troughs.
The enormous capital expenditure needed to drive technological advancements from one manufacturing node to the next have often been out of synch with underlying demand. But right now, the world is in the throes of a global chip shortage that’s particularly acute in China. Global semiconductor manufacturers like Taiwan’s TSMC, South Korea’s Samsung Electronics, America’s Intel and China’s SMIC are all executing record-breaking capex spending to try and catch up with demand. Past experience suggests that this will create excess supply, prompting falling stock prices.
However, current equity valuations do not reflect the view that history will repeat itself anytime soon. Pure play semiconductor stocks are breaching 10-year valuation highs.
The situation is even more extreme in China, where domestic investors clearly believe in SMIC’s ability to achieve self-sufficiency for the nation in the manufacturing of advanced chips. Its A-shares in Shanghai are trading at around 185 times forwards earnings, more than double the level of its shares in Hong Kong, where valuations are more guided by international investors.
SMIC’s soaring share price has encouraged China’s third largest foundry (a facility that makes chips for others) to fast forward its listing plans a year ahead of schedule, according to the domestic press. Anhui-based Nexchip has filed a prospectus with Shanghai’s STAR Market to raise Rmb12 billion ($1.86 billion) in one of the tech board’s largest IPOs.
Nexchip is hoping to achieve a valuation of Rmb48 billion, almost three-and-a-half times higher than its last fundraising round in September 2020. This pre-IPO financing was led by Midea, the white goods manufacturer, which purchased a 5.85% stake on a valuation of Rmb14 billion. Other recent investors include BYD co-founder, Yang Longzhong, through his private equity firm Hui Capital.
Investors are taking note of two big shifts in the sector, both of which have contributed to the global chip shortage. Firstly, there is a major new industry (electric vehicles) suddenly competing for chip supply against the previously all-encompassing smartphone and PC sectors. Secondly, the Sino-US tech rivalry means that existing international semiconductor manufacturers are being forced to set up new supply chains outside of China, while a whole slew of mainland producers are trying to establish domestic champions and break America’s stranglehold.
Over the short-term, Covid-19 has also played havoc with supply and demand calculations. The unprecedented nature of the pandemic made it all but impossible for end user industries to forecast chip demand with any real accuracy for most of 2020. Then at the end of the year, there was a rebound that came sooner and stronger than anyone expected.
This year, new lockdowns across Asia and ensuing production disruptions have further persuaded European and US policymakers about the benefits of establishing supply chains that are closer to home. Geopolitics had already been pushing foundries in that direction and a growing number of semiconductor firms have announced plans for leading-edge fabs in the US rather than in mainland China or Taiwan.
TSMC has a $100 billion, three-year capex strategy, signing off on the construction of its first US fab – a 5nm plant in Arizona – last year. The Taiwanese giant is also said to be considering plans for 3nm and 2nm manufacturing plants in the US as the industry moves to these highest-spec formats over the next decade.
Samsung Electronics is said to be finalising a $17 billion plan to set up a new fab in Texas, while Intel is spending $20 billion to build two more fabs in Arizona.
The US chipmaker is revitalising its foundry operations (after starting to lag TSMC by some distance), spurred by the Biden administration’s plan to mirror China’s Big Fund with a tech investment scheme of its own. The $250 billion US Innovation and Competition Act passed the Senate on June 9. Some $52 billion has been earmarked for the domestic chip industry, including incentives to establish seven to 10 semiconductor fabs.
As WiC has reported, end-user industries in China have been hit by a double whammy: a global shortage of chips, plus Washington’s efforts to stymie their domestic semiconductor manufacturers from moving up the value chain. The auto industry has been among the worst affected by the chip shortage. In 2020 Chinese consumers accounted for 20% of car purchases worldwide, with Chinese vendors delivering just 5% of the auto sector’s semiconductor supply. The problem is most acute for the EV manufacturers, which have surging demand for power management chips (PMICs), display driver chips (DDI), CMOS image sensors and microcontroller units (MCUs), which convert battery power into mechanical energy. But suppliers are feeling constrained too: Shanghai-listed GigaDevice Semiconductor, a growing force in MCU production, said recently that it doesn’t expect the national shortage in chip supply to ease until 2023.
Situations like these have seen traditional car manufacturers moving away from a reliance on just-in-time chip supply for petrol-engine cars to longer-term agreements with chip suppliers – driven also by their production cycles for the new generation of electric vehicles. In May, the Nikkei Asia reported that Volkswagen had established a deal just like this with TSMC, and more contracts of this type seem likely as the industry moves closer to the launch of autonomous vehicles, bringing even more demand for semiconductors for the array of cameras, lidar, radar and ultrasonic sensors that will guide the vehicles.
The building blocks of China’s domestic semiconductor supply line is starting to take shape, anchored by chip designers like Huawei’s HiSilicon, chip manufacturing equipment suppliers such as Shanghai Microelectronics (SMEE), and the chipmakers like SMIC.
The main challenge for the sector in China is progressing from 28nm process nodes to 14nm and smaller – the high-end segment of the market where global chip manufacturers like TSMC are already active. One crucial missing piece in this quest is domestically produced lithography equipment – the most technically complex aspect of the chip manufacturing process.
The global market is currently controlled by Holland’s ASML. But it no longer exports its leading-edge EUV machines to China following pressure from Washington.
SMEE is trying to develop the first Chinese-made 28nm immersion lithography machine and it had published posts anticipating achieving this goal by the end of 2021. These mentions have now been deleted, reports iNews. The Hong Kong news site also notes that SMIC had talked about trialling 7nm chip production by April this year. Since then it has also gone quiet.
iNews wonders whether this is because both companies are finding it difficult to make the technological breakthroughs, especially now that they can no longer rely on new shipments of equipment from overseas. Another possibility is that the two firms are keeping quiet about any progress they’ve made in fear of the US trying to tighten the tech embargo screws even further, it adds.
Certainly SMIC’s first quarter earnings indicate that it still has some way to go in reaching more advanced levels of production, with 28nm and 14nm processes accounting for only 6.9% of revenues.
Another company to watch in the lithography space is Beijing RSLaser Optoelectronics Technology (BOET). It made China’s first 193nm argon fluoride (ArF) excimer laser, one of only three companies worldwide to do so. Huawei has just become the seventh largest shareholder of the group, which emerged from collaboration between the Institute of Optics and Electronics and the Institute of Microelectronics under the Chinese Academy of Sciences. In fact, Huawei has now acquired stakes in 28 domestic semiconductor companies in a bid to build a local supply chain for the high-end chips it needs to power its products.
Founder Securities says that investors should pay close attention to the emerging lithography supply chain, in particular. The broker flags a number of unlisted companies to watch out for in the future. These include Guowang Optics (lenses), Changchun National Extreme Precision Optics (exposure systems), Beijing U-Precision (nanoscale ultra precise measurements) and CheerTech (immersion systems).
Meanwhile Huawei continues to invest in its chip design arm HiSilicon, which now reports a workforce of 7,000 staff. They have been focusing on the design of more complex chips, even though Huawei is having problems finding the foundries to make them at scale. Local champion SMIC doesn’t yet have the capability, for instance, while Taiwan’s TSMC isn’t a production partner because of the political pressure from Washington.
Next off the HiSilicon design board will be a chip for the 3nm process node, likely to be called the Kirin 9010. But in the meantime, Huawei has had to fall back on American supply for the chips that it needs. The new MatePad Pro, for example, will feature Qualcomm’s Snapdragon 870 processor chip for its 10.8-inch version.
Other Chinese companies are trying to vertically integrate their operations by establishing chip design arms. In April, 36kr reported that EV start-up XPENG has set up an R&D team to develop its own chips. It expects the first designs to be rolled out by year-end.
New chip manufacturers are also stepping forward to join SMIC and perennial bridesmaid Hua Hong Semiconductor, China’s second largest foundry. Many specialise in chips for the auto sector, such as GigaDevice, which has become a growing force in MCUs. The list also includes China Microelectronics, which recently deepened its relationship with the Big Fund to tackle the chip shortage. Together with its second largest shareholder, the China Resources group subsidiary has set up a company called Runxi Microelectronics to expand into 12-inch wafers. The goal is to eat deeper into the market share of global giants such as Infineon and ON Semi in power chips for electric vehicles. Investors are intrigued: its shares have risen 25% in the last few weeks alone.
That’s minor excitement compared to Shanghai-listed Will Semiconductor, a producer of sensor chips for vehicles, whose shares have jumped 43 fold since its 2017 IPO. It is aiming for 40% global market share by 2025, mirroring its current 40% share of the Chinese market.
Forthcoming listing candidate Nexchip specialises in DDI chips mainly used in smartphones, notebooks and TVs. Proceeds of the IPO are being used for a second 12-inch fab in Hefei, the capital of Anhui province. Nexchip was set up as a joint venture with Taiwan’s Powerchip Semiconductor, the world’s seventh largest foundry, which owns 27%. The city government is the majority shareholder with a 53% stake
All of this effort is based on the belief that the Chinese semiconductor sector can close the gap on its international rivals. Commentators are divided on the prospects of that happening, however. Some say that the sheer weight of investment in the industry will spur domestic producers forward, bringing their capabilities close to those of the global leaders. Others think it will take much longer – a decade or more – for the Chinese to challenge in a meaningful way, in part because technical standards are constantly moving forward, keeping the leaders ahead of the Chinese chasers.
Longstanding efforts from policymakers to buoy local chipmaking have had an impact, but not a transformative one. Beijing set a goal in 2015 of sourcing 70% of its semiconductor needs locally by 2025. Local sourcing has been lifted from about 10% to 16% so far, making the 2025 goal look unlikely.
Yet the policy goal is still in place and Chinese semiconductor stocks were cheered this month by news that Liu He – the man picked by Xi Jinping to lead China’s negotiations in its trade dispute with the US – has also been tasked with spearheading state support for the development of so-called third-generation chip development.
The hope is that the Chinese can make ‘leapfrog’ gains in new technology standards that take them to pole position in the sector. “For our country, technology and innovation is not just a matter of growth. It’s also a matter of survival,” Liu told a gathering of China’s top scientists in May.
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