U.S.-China Trade War Hobbles China's Semiconductor Industry Ambitions And Rattles Stocks – Investor's Business Daily

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China’s lagging efforts to become a self-sufficient chip-making province have been dealt a serious blow by U.S. trade sanctions. (© Dave Cutler)
U.S. trade sanctions have dealt a serious blow to China’s goal of becoming self-sufficient in semiconductor manufacturing in the next 10 years. But the U.S.-China trade war also has rattled global semiconductor stocks.
China currently produces only 16% of the chips it needs for its domestic tech sector. It wants its semiconductor industry to cover 70% of its needs by 2025. But analysts say China won’t achieve that lofty goal as the U.S. restricts sales of critical chip-manufacturing gear and other technology to China.
The U.S. late last year imposed restrictions on trade between U.S. companies and China’s telecom giant Huawei Technologies. In September, the U.S. raised the bar to include Semiconductor Manufacturing International Corp., or SMIC.
The moves have semiconductor industry officials and analysts waiting for the next shoe to drop in the U.S.-China trade war.
“The odds of an escalation of the tit-for-tat trade war are virtually 100%,” Robert Maire, president of Semiconductor Advisors, told Investor’s Business Daily. “China is going to place U.S. companies on its ‘unreliable entity list.’ ” Companies on the list would face restrictions on China exports, imports and investment.
Likely targets for China’s retaliation include U.S. firms such as Cisco (CSCO), Dell Technologies (DELL) and Hewlett Packard Enterprise (HPE), analysts say.
The U.S. government’s move last year blocked sales of semiconductor products to Chinese telecom equipment giant Huawei. Companies that want to do business with Huawei now must obtain export licenses from the U.S. Department of Commerce.
In September, the Commerce Department imposed similar restrictions on SMIC, China’s largest chip foundry, citing an “unacceptable risk” that the technology would be diverted to military uses. The new rules require semiconductor equipment makers to obtain export licenses from the Commerce Department to do business with SMIC. On Oct. 4, SMIC warned investors that the new U.S. restrictions could cut it off from key technology and have “material adverse effects” on its business.
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SMIC is a cornerstone in China’s efforts to grow its domestic semiconductor industry. But analysts say it is three to five years behind foundry peers Samsung Electronics and Taiwan Semiconductor Manufacturing (TSM). SMIC would need advanced chipmaking gear from ASML (ASML) and others to catch up in the race to make smaller, more powerful integrated circuits.
“Investors don’t realize the dominoes that are in motion and the likelihood of this going beyond SMIC,” Maire said.
Next, the U.S. could expand the industry trade skirmish to include China’s memory-chip makers, he says. They include Nand flash chipmaker Yangtze Memory Technologies and DRAM chipmaker ChangXin Memory Technologies.
The U.S. sees Huawei, SMIC and other firms as national security risks because of their ties to Beijing and the country’s military. Moreover, the Trump administration has accused Chinese firms of unfair trade and theft of U.S. intellectual property. The U.S. has blocked trade with other Chinese firms involved in supercomputers, artificial intelligence and surveillance.
Meanwhile, U.S. trade restrictions on business with Huawei and other Chinese firms have crimped sales for semiconductor stocks like Micron Technology (MU) and Xilinx (XLNX). The SMIC trade restrictions are also seen hurting major semiconductor equipment suppliers like ASML, Applied Materials (AMAT), KLA (KLAC) and Lam Research (LRCX).
IBD’s Semiconductor Equipment industry group on Thursday ranked a weak No. 120 out of 197 industry groups. Three months ago, it ranked No. 23. IBD’s Semiconductor Manufacturing group sits at No. 75, and the Semiconductor Fabless group is at No. 25.
The fabless manufacturers group (companies that design chips but don’t own chip fabrication plants, or fabs) has a year-to-date gain of 46%. The chip manufacturers group is up 10.5%, and the equipment makers’ group has an 11.6% gain.
China’s domestic production of integrated circuits accounted for 15.7% of the chips that the country needed in 2019, according to research firm IC Insights. That’s up only slightly from five years earlier, when it produced 15.1% of its chip needs, the report said.
Looking ahead, IC Insights forecasts China reaching 20.7% of its integrated circuit needs in 2024. Five years ago, before the recent U.S.-China trade war, the country set goals of hitting 40% self-sufficiency in semiconductors by 2020 and 70% by 2025.
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When you exclude foreign companies that produce chips in China, however, the numbers look worse. Chipmakers want to be close to the factories that use their products in devices such as smartphones and personal computers. Therefore, Intel (INTC), Samsung, SK Hynix, Taiwan Semiconductor and other foreign companies all have factories turning out chips in China.
China-headquartered companies accounted for only 6.1% of the country’s $124.6 billion integrated-circuit market in 2019. IC Insights estimates that China-based companies will account for only 8.5% of its chip consumption in 2024.
The bulk of chips used in both China and the U.S. are manufactured in Taiwan and South Korea. The U.S.-China trade war makes it hard for China to narrow the gap.
Bill McClean, president of IC Insights, doubts China will ever catch up to its foreign semiconductor competitors, much less become self-sufficient.
“Just throwing more money at it now doesn’t actually help because the technology is so complex and they’re so far behind,” McClean told IBD.
In October 2019, China announced a $29 billion state-backed fund to invest in its domestic semiconductor industry. The goal was to reduce its dependency on U.S. technology.
“If they had started the program they’re doing now 15 years ago, they may have had some decent success. But this is really late to be starting,” McClean said.
Meanwhile, fallout from the U.S.-China trade war continues.
U.S. lawmakers have proposed $25 billion in subsidies for chipmakers to drive U.S. domestic manufacturing, Bloomberg reported in June. In addition, Taiwan Semiconductor is looking for incentives to build an advanced chip plant in Arizona.
U.S. chipmakers control 47% of global semiconductor sales, but only 12% of those chips are made in the U.S.
Some analysts believe China will retaliate against the U.S. sanctions by blocking the sale of SoftBank-owned chip design firm Arm to graphics-chip maker Nvidia (NVDA).
But since China-based chip firms are using Arm-based designs, it might have no choice but to approve the deal, says Rosenblatt Securities analyst Hans Mosesmann.
Nvidia Chief Executive Jensen Huang could decide to go ahead with the acquisition even if China doesn’t approve it, Mosesmann told IBD. Under that scenario, Arm wouldn’t do business in China, he says.
Huang is interested in Arm for its technology, not necessarily its licensing business, Mosesmann says. Nvidia wants to make central processing units that work closely with its graphics processing units for optimal computing performance, he says.
The U.S.-China trade war may accelerate. China is likely to wait until after the Nov. 3 U.S. presidential election before deciding how to respond to the latest U.S. trade sanctions.
“If there is a change in administration, there would be a different negotiating situation,” Mosesmann said. “If (President) Trump wins reelection, this could escalate.”
One concern on Wall Street is that China might attempt to exert control over Taiwan, much as it has done recently with Hong Kong. China considers Taiwan a runaway province. Taiwan is home to a large share of the world’s chip manufacturing capacity, including the global leader in advanced semiconductor manufacturing, Taiwan Semiconductor.
The U.S.-China trade war could evolve into a “new cold war,” an analyst from research firm Fitch Solutions said Sept. 28, CNBC reported.
Speaking at a virtual seminar, analyst Darren Tay said the U.S. and China have “diametrically opposed values.”
“By a new cold war, I mean an all-out, perhaps generation-long, global economic, military and ideological struggle that could lead to a bifurcation of large parts of the world into a pro-U.S. bloc and a pro-China bloc with significant numbers of countries caught in between,” Tay said.
The U.S.-China trade war isn’t the only factor weighing on the chip sector.
Earlier this year, just as the global semiconductor industry was recovering from a cyclical downturn, the Covid-19 pandemic struck. The pandemic disrupted supply chains and led to a recession that negatively affected some end-market demand for semiconductors.
Monthly data from the Semiconductor Industry Association indicates that the June quarter was a bottom for the semiconductor sector, Evercore ISI analyst C.J. Muse said in a note to clients Oct. 5.
The Semiconductor Industry Association expects semiconductor sales to rise 4% year over year in 2020. That’s after chip sales dropped 12.3% in 2019.
“The (chip) cycle is alive and well; it just got pushed out by two or three quarters,” Mosesmann said.
Despite the U.S.-China trade war, all is not gloomy in the semiconductor industry. The second-quarter earnings season was mostly upbeat for semiconductor stocks.
Many top semiconductor stocks delivered beat-and-raise June-quarter reports. They included Advanced Micro Devices (AMD), Broadcom (AVGO), Nvidia, Qorvo (QRVO), Qualcomm (QCOM) and Taiwan Semiconductor.
Semiconductor companies with exposure to personal computers, cloud data centers and 5G wireless outperformed in the June quarter. Those linked to the automotive and industrial markets as well as memory chips underperformed.
“Semiconductor revenues have held (up) much better than feared year to date in 2020, as evidenced by the large number of beats/raises in Q2 earnings season,” Deutsche Bank analyst Ross Seymore said in an Oct. 4 report. Positive impacts from the work-from-home trend during the Covid-19 pandemic offset some negative economic impacts, he said.
The third-quarter earnings season for semiconductor stocks got off the ground with ASML on Wednesday, and Taiwan Semiconductor on Thursday.
Taiwan Semiconductor reported that both its earnings and revenue growth for the quarter came in above analyst forecasts, with earning growth topping 90% for the second consecutive quarter. Management offered a robust fourth-quarter outlook, with revenue guidance above expectations.
ASML also topped views. Earnings soared 83%, revenue gained 42%. Both numbers were above expectations, marking the company’s best earnings gain in 3-1/2 years. Fourth-quarter guidance was in line with expectations, and management’s 2021 outlook called for low-double digit growth, leaving investors somewhat disappointed.
Follow Patrick Seitz on Twitter at @IBD_PSeitz for more stories on consumer technology, software and semiconductor stocks.
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