Win-win ties will make the chip cake bigger for Chinese firms

As a string of Chinese technology companies, including Baidu Inc and Xiaomi Corp, announced their plans to manufacture vehicles, many people worried that they will have to address lots of challenges, including the ongoing global chip shortage woes.

Starting from the end of last year, a severe shortage in semiconductor products has been dogging industries like automobiles, smartphones and personal computers, and forced some companies to cut production.

Amid the chip shortage pain, discussions on semiconductor technology have been particularly hot in China, chiefly because the nation is the world’s largest market for integrated circuits.

Since 2015, China has been spending more on chip imports than on crude oil imports annually.

But the self-sufficiency rate of China’s integrated circuits is only 15.9 percent. Chinese companies account for only 38.7 percent of chips produced in the nation every year. The rest are produced by overseas companies such as Samsung, which has chipmaking plants in China.

These data highlight the imbalance between chip supply and demand in the Chinese market. Of course, such strong demand is not just for the Chinese market.

For example, Huawei and Xiaomi buy tons of mobile phone chips every year, but many of their products are sold overseas. However, from the perspective of direct supply and demand, there is still a severe shortage of chips.

According to the financial data provider Wind, many foreign semiconductor companies’ sales in the Chinese market in recent years have accounted for a relatively high percentage of their overall sales.

The Chinese market, for instance, accounted for nearly two-thirds (65.4 percent) of Qualcomm’s overall revenue. Broadcom derived 53.6 percent of its sales from the Chinese market. This shows that the Chinese market is the main source of revenue and profit for these foreign semiconductor companies, which also highlights China’s heavy reliance on these overseas companies.

In fact, there is an urgent need for chips in both mass-consumer sectors like mobile phones and industrial manufacturing fields such as automobiles.

Chips are highly profitable. If domestic enterprises want to upgrade their technology and pursue the upstream of the industrial chain, they will undoubtedly encounter resistance. This is also the reason why technology powers have created barriers for China.

From the perspective of the capital market, the chip industry is in cyclical fluctuations, and there are cyclical investment opportunities, which can fuel the growth of domestic chip companies.

Generally speaking, cyclical investment opportunities are divided into long-term, medium-term and short-term ones.

Long-term investment opportunities mainly come from the emergence of disruptive new technologies in downstream terminal demand, like new energy vehicles, autonomous driving, cloud computing, artificial intelligence and the internet of things. These technologies give new companies an opportunity to challenge established chip giants.

Mid-term investment opportunities exist in the stage of expanding production capacity. It takes time for new plants to materialize from an idea. Similarly, it takes time for an investment project to reach plant construction and operations, to scale up production to achieve stability in output. This is a medium-term opportunity.

Short-term opportunities lie in the inventory cycle. For example, the recent supply shortage of automotive chips is partly because high-margin, large-volume chips such as mobile phone terminals occupy the larger production capacity of factories. Coupled with the major structural adjustments in the automotive industry in 2020, a severe supply shortage emerged.

Under the superposition of long-term, medium-term, and short-term cycles, the chip sector is fluctuating accordingly and the industrial restructuring or reshuffle is going on. This is particularly obvious in the capital market: of the 51 largest mergers and acquisitions in the semiconductor industry, 32 were reached in the past six years (2015-20).

Last year, the total value of mergers and acquisitions in the semiconductor sector set a historical record, with three of the top five transactions in history inked in 2020. This fully reflects the fact that the capital market moves in accordance with the changes in the industrial cycle.

M&A deals are, in fact, a way for companies to achieve growth. A company has two growth models, namely, endogenous growth and extensional growth. The former refers to doing everything by itself.

But affected by factors such as accelerated technological iteration and industry cycle fluctuations, companies often adopt another growth mode in order to quickly seize opportunities — that is extensive growth, which refers to M&A.

For Chinese chip companies, I think dualcirculation is also needed. On the one hand, China must firmly hold the chip design and manufacturing in its hands; on the other, the nation can use external forces to achieve extensional growth.

Under the global trend of cooperation and mutual benefit, if companies can leverage their respective advantages through cooperation, they may be able to make the cake bigger together.

Chinese tech company Wingtech’s acquisition of Dutch company Nexperia is a good example. Wingtech started from assembling devices for smartphone brands such as Huawei to Lenovo, and it gradually became the world’s number one ODM (original design manufacturer) enterprise.

However, ODM companies are in the middle of the industry chain and are squeezed by both ends — the upstream are the hightech chip giants, and the downstream are the mobile phone giants.

Therefore, if an ODM company wants to transform, it needs to walk on “two legs”, and M&A deals are a relatively quick way to do that.

Wingtech, therefore, set its sights on Nexperia, which is a world-class IDM (integrated device manufacturer) enterprise whose business runs through multiple industrial chains, including chip design, chip manufacturing, chip packaging and testing.

The acquisition also helps Wingtech enter a new area: the automotive industry. Wingtech also gained a fast track to obtain vehicle manufacturer supplier certification.

Why can Wingtech acquire a company in Europe? In other words, what is the attraction of the Chinese market? I summarize the advantages of the Chinese market as “3M”. To wit: market, money and manufacturing.

The market, that is China’s huge market, boasts consumer electronics brands and new energy vehicle brands, which are gaining momentum.

Money means the high valuations commanded by the chip industry players in China’s capital market and investors’ preference for hardcore technology.

Manufacturing is China’s advantage, given its industrial agglomeration, industrial coordination, and labor quality.

Therefore, the positive interaction between the domestic market and the outside circulation is the only way for the development of Chinese enterprises.

For Chinese chip companies, I think dual-circulation is also needed. On the one hand, China must firmly hold the chip design and manufacturing in its hands; on the other, the nation can use external forces to achieve extensional growth.