Semiconductor Design and Production – China’s Need for Autonomy

day 10.08.2021 * Reading time: 10min.

 
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Semiconductor Design and Production – China’s Need for Autonomy

 

Due to the difficult situation with #semiconductors, I decided to take a closer look at this market, with emphasis on the role of China in this puzzle. Here are the most important of my observations:

Since the discovery of the transistor in 1947, semiconductors have driven the larger USD 3,000 billion IT sector and everything electronic. Over the last 30 years, the increasing usage of electronics in nearly every industry has driven worldwide sales up by roughly 7.5 percent per year, more than double the rate of global GDP growth. Defying the worldwide sanitary and economic crises of 2020, the sector recovered from its 2019 collapse, with global revenues up 5.9%, thanks to a pricing rebound and the introduction of new generation chips.

China’s Dual Circulation plan, which was introduced in 2020, has highlighted semiconductors as a top focus.

Over the last two decades, China has generated a cumulative USD 3,700 billion tradesurplus from computers, television sets, and cellphones since entering the WTO in 2001.

China-based businesses designed and marketed more than 60% of the 1.3 billion smartphones shipped worldwide in 2020.

The government has fallen short of its goal of covering 40% of local semiconductor demand by 2020, and it is unlikely that it can meet the 70% target set for 2025.

In recent years, Chinese semiconductor businesses have outpaced worldwide competitors in terms of growth. They began at a disadvantage, with a substantial technology gap, and growth has been uneven among segments.

For nations exporting chips that rely on mature technology and serve well-established sectors, China’s plan will increase the risk of import replacement by domestic manufacturing.

Because of the high stakes and high risk character of rapid development in such an R&D and capital-intensive business, it is also likely to generate further large credit events among Chinese enterprises.

Having said this, it is worth to check what the present state of China’s semiconductor autonomy goals and its ability to achieve them really is.

The overall picture is simple: no Chinese firm has yet to establish itself as a heavyweight player.

Asian players dominate silicon wafer manufacture, with Shin-Etsu and SUMCO of Japan accounting for more than half of worldwide sector revenues. Notably, GlobalWafers Co., Ltd. of Taiwan has agreed to buy Siltronic AG of Germany, putting four businesses in control of around 90% of the market. The total market share of emerging Chinese wafer makers is around 5%.

Taiwanese companies dominate foundry capabilities, with TSMC alone accounting for more than half of global capacity and being the only firm to master the industry’s most advanced manufacturing standard, along with Samsung Semiconductor. SMIC and

Shanghai Huahong Grace Semiconductor Manufacturing Corporation are two significant Chinese foundry companies.

Semiconductor manufacturing equipment is an oligopoly, with a few companies controlling the machine tools used in each phase of the semiconductor manufacturing process (deposition, lithography, etching etc.). American firms and technology are everywhere and they’ve been exploited as a bargaining chip in the US-China trade and technology conflict.

#Fablesscompanies, or those that create chips but outsource manufacture to foundries, have little in common and specialize in a limited number of semiconductor applications (power, memory, telecom etc. chips). The largest firms are predominantly American or Taiwanese, but China’s growth is most evident in this area, with several small but quickly increasing players.

Integrated design manufacturers develop and produce chips for a wide range of industries and applications. The leading corporations are primarily from the United States and Europe.

Make it or break it: China’s search for the autonomy in semiconductors:

Current restrictions imposed on companies such as Huawei (which faces restrictions for chips manufactured by a third-party company using US technologies) or SMIC (which can no longer purchase state-of-the-art US machine tools) are effectively slowing China’s capacity to manufacture and design advanced chips.

China is the world’s largest market for semiconductor manufacturing equipment, accounting for an estimated 26% of a USD70 billion sector.

Over the last decade, SMIC – China’s largest foundry player, has burned around USD6.9 billion in cash.

The #ChinaIntegratedCircuitInvestmentIndustryFund (CICIIF, also known as “The Big Fund”), the country’s financial arm for supporting its semiconductor industry, was able to invest an estimated RMB340 billion (about USD 50 billion) in Chinese semiconductor companies in its first two rounds (2014 and 2019).

The decision to let TsinghuaUnigroup, a holding company that owns some of China’s greatest and most sophisticated semiconductor businesses, to go insolvent in 2020 has sent a signal that the nation may not be prepared to finance its champions at all costs.

What exactly is the autonomy of China in the semiconductor sector aiming at and what are the opportunities and threats for China in the context of the fast changing semiconductors’ environment?

Growing autonomy in semiconductors would serve three main targets:

Support China’s broader ambition to transition to a more knowledge oriented economy with the development of high valued added manufacturing and services, and help reduce the country’s largest trade deficit source.

Reduce reliance on foreign parties for the manufacturing of chips with potentially strategic purposes (surveillance, aerospace, defense).

Help the Chinese electronic ecosystem find new growth opportunities and anticipate further erosion of the country’s market share in global exports.

The Chinese economy is confronted with two major challenges: decreasing potential growth and a worsening external environment. Due to falling labor supply and slower productivity and capital investment, our growth potential model predicts that China’s GDP growth would average between +3.8 percent and +4.9 percent during the next decade (down from +7.6 percent in the 2010s).

In this environment, the #dualcirculation approach is set to take center stage in China’s 14th five-year plan as a means of achieving more sustainable growth, reducing the country’s reliance on forces outside its control.

Taiwan, Malaysia, Singapore, Thailand, and Chile stand to lose the most in the medium term as China pushes toward industrial autonomy.

China is anticipated to expand direct investment in innovative developing economies including Indonesia, India, Thailand, Mexico, and Chile. Chinese external investment has slowed but not ceased in recent years, and the #BeltandRoad Initiative remains a long-term ambition for Chinese officials.

Rising debt, zombification and sluggish technical development are all long-term threats. In comparison to the United States, Japan, and Germany, China’s R&D expenditure is heavily subsidized by the government. Strong government intervention may result in overcapacity and resource misallocation.

Rafal Ciepielski

Rafal Ciepielski

CEO RCieSolution

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The views expressed in this document do not constitute research, are not investment or commercial advice, and do not necessarily reflect the views of all management teams. They change over time.