Chinese Semiconductors - New Oil

In a digital age, where everything from manufacturing to the defence industry, increasingly relies on semiconductors, many have referred to them as the “new oil” of the 21st century. The Chinese government understands this and has made the semiconductor industry in China a priority leading to beneficial policies not only aimed at lowering costs of production but also directing demand of domestic customers to incumbents. In fact, in 2015, China published the Made in China 2025 Plan in which aspirational goals were set to achieve 70% self-sufficiency in semiconductors by 2025. All this policy support is leading to a favourable industry backdrop and strong tailwinds, which should help the current incumbents.

China Faces a Fearsome Self-Reliance Challenge

In 2021 the Chinese semiconductor industry grew 28% to $186.5bn in total annual sales, making up 36.5% of the global integrated circuit (IC) market, however, the China-based IC production made up $31.2bn of this or just 16.7% of the Chinese market, this is up from 10% in 2011, ten years ago. IC Insights believes China can reach 21% semiconductor independence by 2026. This is a far cry from the 70% self-sufficiency goal of 2025. Regardless of this harsh reality, the Chinese communist party realises its acute strategic imperative and is pulling out all the stops to bridge the gap of semiconductor self-sufficiency.

Throw Money at the Problem, Smart Money

Central to China’s semiconductor industrial policy is the National Integrated Circuits Industry Development Investment Fund which overall amounts to an unparalleled $73bn, which does not even account for government grants, equity investments, and low-interest loans which exceeds $50 billion alone. Overall, the Chinese state has earmarked $150bn for semiconductor industry support through to 2030. As one can see below, this is more than the USA and Europe combined.

The Chinese local governments have had a fair amount of success in investing in chip manufacturers and other tech companies like the municipal government of Hefei (see: www.bloomberg.com/news/features/2022-02-06/where-is-china-investing-communist-leaders-are-becoming-venture-capitalists). Even though local governments have had success thus far, Western capitalists would likely view this as a public sector power grab with dangerous risks of interference which generally leads to poor investment returns. It is interesting to see that many local government entities are professionalising by employing third party investors and taking on more of a limited partner role in the process.

Other Incentives

Other Chinese government incentives tailored to support its domestic semiconductor sector include grants, reduced utility rates, favourable loans, significant tax breaks, and free or discounted land.

Boston Consulting Group found the cost of building and operating an advanced logic a fab (manufacturing facility) in China is 37% lower than doing so in the U.S, while a memory fab can cost up to 34% less. This is obviously a huge advantage over global peers.

Conclusion

Although the Chinese government has a seemingly insurmountable task of making the Chinese semiconductor market self-reliant, the fact the Chinese Communist Party is investing alongside private companies, giving businesses real cost advantages and demand security should make for favourable outcomes for investors. We have bought exposure through the Global X China Semiconductor ETF (9191:HK) which offers investors exposure to Chinese semiconductor manufacturers.

06 June 2022

Chinese Semiconductors - New Oil
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