Financing a revolution

Rarely a week goes by without a mention in the media of China’s bid to become a major player in the world of semiconductors. Such headlines are normally accompanied by an explanation of the yawning gap the country still needs to bridge in order to achieve that goal. The latest data underlines  just how far behind the United States it remains.

This month research firm IC Insights estimated that mainland China holds a tiny 4% share of the global semiconductor market, a long way back from America’s 54%, or the South Koreans on 22%. The figures include both fabless IC companies and integrated design and manufacturing (IDM) concerns that both design and manufacture silicon chips.

In recent years, Beijing has devoted increasing resources to the situation, including setting up Shanghai’s STAR Market in 2018 to seed a new generation of challengers in the race to catch up.

On the surface, one such contender is Vanchip Technology, which raised Rmb2.7 billion ($424 million) from a STAR Market IPO earlier this month. Vanchip designs the RF – or radio frequency – chips used by smartphones, wireless routers and smart wearable devices. Most of its sales are made from designs of a particular kind of chip (called power amplifiers) to smartphone companies, as well as a small group of ODM manufacturers. Some of its main customers include Huawei and Taiwan’s MediaTek.

The company was set up more than a decade ago by Rong Xiuli, who began her working life at a tractor institute in Henan province, before becoming a mobile phone sales agent and then the founder of a smartphone brand called Tianyu.

Rong founded Tianyu in 2007 at a time when Nokia still dominated the Chinese handset market. She had a few years of success with a strategy that drew heavily on other phone designs and relied extensively on contract manufacturers to put them together. She also made bulk sales to agents, allowing them to set their own prices.

Tianyu then lost ground to the new generation of domestic smartphone makers so Rong changed direction, starting up Vanchip (the company’s Chinese name is Weijie Chuangxin) in 2010. In doing so, she also chose to focus on production of some of the semiconductors required by her former industry.

Rong’s former career inspired local headlines last month about her journey from shanzhai (see WiC101) to semiconductors. The story might even be seen as a parable for China’s quest to transform from copycat manufacturer into a producer of core components for the tech sector.

Yet Vanchip’s rise is not simply a mainland Chinese success story since the company’s largest shareholder is Taiwan’s MediaTek. The world’s largest smart phone chip manufacturer purchased a 40% stake for $40 million in 2019 through its Gaintech subsidiary and held 28.15% just before the IPO.

MediaTek viewed Vanchip as a springboard to diversify its product range to RF chips and break the stranglehold that rivals Quoro and Skyworks Solutions have on the Chinese market. The two US companies have a roughly 40% market share each in 4G power amplifiers, while Vanchip is the leading domestic supplier, according to CB Insights.

Just prior to MediaTek’s investment, Vanchip’s sales had suddenly dropped by a third to Rmb284 million in 2018. Since then, it has done a good job growing them back again, with sales almost doubling to Rmb3.5 billion last year.

Vanchip is yet to make a profit, reporting a net loss of Rmb68.4 million in 2021 compared with red ink of Rmb77.7 million in 2020.

It did not get off to a good start on the STAR Market. Upon its trading debut on April 12, it quickly dipped below its Rmb66.6 offering price to close at Rmb46. As of this week, it had reclaimed some ground, trading at around Rmb57. At this level, Vanchip has a price-to-book value of around 16.3 times, a substantial premium to its bigger Nasdaq-listed comps, Quoro and Skyworks, both trading at about 8 times.

One reason for the premium is Vanchip’s potential to eat into the American firms’ market shares. However, domestic competitors believe that its pricing power is limited because the vast majority of its revenues are concentrated around its five main customers. Gross profit margins have also been falling, perhaps as a result of the push to grow revenues.

Commentators also argue that Vanchip needs to broaden its product range and continue to ramp up 5G sales. At the moment the vast majority of sales are concentrated in power amplifier modules, a function that boosts signal transmission between devices.

But broadening out into other kinds of RF front-end chips like filters and switchers is going to require higher spend on R&D, an area where Rong was criticised in her previous career at Tianyu for investing too little.

Vanchip’s R&D spend as a proportion of revenues has been falling, although that’s largely because of the dramatic surge in sales. Actual spend on research and development is up substantially over the same period, although tech website 36Kr still reckons it is below the levels of comparable companies.

“There are lessons from Tianyu’s mobile phone business: will history repeat itself?” the tech website asks.

The same website argued last month that a share sale on Shanghai’s tech bourse is only the beginning of the journey for semiconductor firms, many of which are struggling to build a profitable business. Pre-IPO, much of the talk about a company’s prospects is rooted in the performance of its products. But once it has debuted on the market it needs to find profits – or investors will soon lose interest 36Kr added.

“For many domestic chip firms, it is only a qualifying competition before they list. The real knockout competition starts afterwards,” the website warned.

According to China Securities Journal, the STAR Market welcomed 46 domestic semiconductor companies (across design, manufacturing, packaging and testing, materials, and equipment) between its 2018 launch and the end of 2021. Many have benefited from a favourable policy environment, as part of Beijing’s bid to bolster homegrown chipmakers, and this has also spilled over into positive sentiment from investors, reports The Paper.cn.

“Semiconductors have been a good business story, especially in recent years. Coloured by the rivalries of the great powers, the sector has been given a golden chance at development and large amounts of capital have poured in. Almost all the domestic semiconductor-related companies have got extensive attention from the market,” it concluded.

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