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28 November 2018

US sanctions threaten China’s massive mobile memory investment

The heart of the US-China stand-off over technology is in semiconductors, the foundation of the whole industry and an area where China is determined to become a global powerhouse.

But it will take many years to achieve that. US and Taiwanese chip manufacturers are well ahead in terms of process technology and many design aspects. US chip giants like Intel and Qualcomm are deeply embedded in China, investing in local companies and sharing expertise, which will help the country build its own industry, but – hopefully for the US firms – will give them a permanent role in the value chain.

Myson Robles-Bruce, a semiconductor analyst at IHS Markit, put it well when he said recently that the trade battles in the chip industry will be “a bruising zero-sum game injurious to both sides in which there are no winners”. Escalating tit-for-tat tariffs, as well as probes on the grounds of ‘national security’, are being mounted by both countries, with the semiconductor sector a particular hotbed – and one which affects the whole equipment and device chain.

“A tariff war between the world’s two biggest makers and consumers of semiconductors is likely to spread throughout the vast electronics supply chain involving multitudes of markets, trades, and businesses, and both American and Chinese companies could end up suffering,” Robles-Bruce wrote in the blog post, following President Trump’s decision, earlier this year, to impose 25% tariffs on about $34bn worth of Chinese products, including many related to chips and technology.

There are genuine issues to address around protection of US intellectual property in China, and even some security fears, but the hi-tech industries of these two countries are too entwined to make trade sanctions anything but harmful for both sides.

According to IHS Markit, almost 50% of the world’s chips are designed in the US, but a high proportion of assembly, testing and packaging is done in Greater China. That means most of the revenues of US chipmakers would be subject to US tariffs when they re-import their products after test and manufacture. The same is true of many consumer electronics products.

Last week, Bloomberg highlighted the plight of a Chinese semiconductor company called Fujiann Jinhua Integrated Circuit Co (Jinhua), which epitomizes the impact of the current trade wars on that country’s hi-tech plans, and on access for the whole world to affordable, advanced technologies and a competitive ecosystem.

Jinhua has built a $6bn chip plant in the southeastern coastal city of Jinjiang, and was planning to produce about 60,000 wafers a month, mainly targeting the smartphone memory market, a high growth sector in which the industry is heavily reliant on the dominant Samsung. Backed by hefty local government investment, this was part of China’s aim of becoming a competitive producer of mobile memory chips, an area where it has not been a first-rank supplier.

But then the US Department of Justice accused Jinhua of stealing American technology, prompted by a complaint made by memory maker Micron, and that led to the Department of Commerce barring the Chinese start-up from buying semiconductor manufacturing equipment from the USA. US and even European consultants and suppliers, which had been working with Jinhua, backed away and operations have ground to a halt for now.

An engineer told Bloomberg: “Only Xi Jinping and Donald Trump can save us now. We only hope the government sees us as important as ZTE.” The Chinese government lobbied hard to get the US ban on ZTE’s purchase of US technology lifted, though the ripple effect of these disputes was seen clearly when Chinese antitrust authorities failed to clear Broadcom’s proposed acquisition of Qualcomm, leading to the collapse of the deal.

The Jinhua case, like the ZTE one, highlights China’s vulnerability to the USA because of its heavy reliance on US technology, especially in the telecoms, semiconductor and mobile fields. That, in turn, makes investors and customers nervous, even if the sanctions are removed. In the medium term, it will intensify China’s determination to become self-sufficient and reduce its massive $200bn bill for hi-tech imports. And the government will certainly be looking for non-US sources of component, skills and equipment.

However, in the short term, it is impossible to get around the USA entirely in this market. Hence why a company like Jinhua, which had built up a staff of 1,000 and licensed DRAM technology from United Microelectronics, is now in a state of suspended animation, unable to buy parts from its key suppliers, such as Applied Materials, ASML and KLA-Tencor. In the case of ASML, the company – supplier of critical EUV machines for the production lines – is not even American, but Dutch, but it pulled out anyway.

Of course, the effect is felt in the USA as well as China. Just as Qualcomm would have lost one of its biggest customers for smartphone chips, had the ban on selling to ZTE been maintained, so Applied Materials recently delivered a weak sales forecast, partly because it had been relying on “meaningful sales” to Jinghua in the coming quarters. “In the absence of this export restriction, we would have been up sequentially in our semi systems business into Q1,” CFO Daniel Durn said.

Jinhua was named by the Chinese premier as one of three “national champions” of the bid to build a homegrown semiconductor industry. The others are Tsinghua Unigroup’s Yangtze River Memory, and Hefei Changxin, both based in the central Anhui province.

Now there are nerves about these companies t0o. “The majority of market watchers believe that Hefei and Fujian Jinhua — both central to Beijing’s ambitions to develop homegrown semiconductor behemoths — will be forced out of the market,” wrote two analysts with Samsung Securities, M.S. Hwang and Dexter Lee, in a client note this month. “Concerns are growing that Hefei and Tsinghua Unigroup might be the next to be slapped with US sanctions.”