China's Future Investment Watch series - China Chips: Will China Dominate the World Semiconductor Market in 5 Years?
Antitrust, reform in education, real estate and medical care policies, Common Prosperity... all of these show that China is undergoing earth-shaking change. These changes have brought large uncertainty, making many investors afraid to invest in Chinese projects and companies. However, over the next decade, China sure will become the world's largest economy. How to better understand the opportunities and risks of the Chinese market and deal with certainty and uncertainty is a crucial problem. EqualOcean launched a series of research, China's Future Investment Watch, hoping to provide clues for global investors.
Years later, we may witness a historical scene in which President Joe Biden holds up a silicon wafer mold at a CEO Summit on Semiconductor and Supply Chain Resilience and tells the participants that the United States needs to construct new chips infrastructure. In fact, there has been a consistent voice in the Chinese media stating that China will overtake the United States in the chips and semiconductor fields within five years. From this point of view, it is not difficult for us to understand Biden's concerns. But can China really do it? This article may give you some clues for you to make up your own mind.
The change of the US chips restriction policies
In April 2018, the US Department of Commerce announced that it would prohibit US companies from selling parts, goods, software, and technology to ZTE for seven years until March 13, 2025. In December 2018, the animosity got worse: Meng Wanzhou, the CFO of Chinese telecom and electronics company Huawei, was arrested in Canada at the United States' request to handicap Huawei's 5G networks technology. Since then, the United States has banned chips manufacturers, including TSMC, the world's largest one, from selling advanced chips to China.
During the Trump Administration era, the limiting of China's chip industry was more direct: the US government introduced measures to hinder technological exchanges between China and the United States. The first measure was to impose export controls prohibiting US companies and their allies from selling chips and providing OEM services to China. The second was investment control, which limited Chinese companies' investment and acquisition activities in US chip companies. The third was restricting the exchange of related talents.
By the Biden Administration era, it became very clear that the high dependence on overseas production capacity was the weakness of the US chip supply chain. Many American companies only master research technology but outsource chip production to overseas manufacturers. For example, the chips used by Apple and Volkswagen nearly all came from TSMC.
By contrast, the Biden Administration pays more attention to remaking US chips and semiconductor industries. It not only continues the technical restrictions and blockade against China but also intends to suppress the development momentum of China's science and technology through broad deployment. Its first measure was paying more attention to the research investment in science and technology in the United States to ensure its global leadership. On June 11, 2021, the White House announced a comprehensive plan to ensure the supply chain of critical products from drugs to chips, in part in response to the growing economic and political impact of its Asian competitors. On the same day, the US Senate passed a USD 52 billion bill to support domestic chip manufacturing (American Innovation and Competitiveness Act), expressing Congress's support for the reconstruction of chip infrastructure in the United States. For the second measure, the Biden Administration plans to cooperate with other Western democracies to establish a unified semiconductor front against China's influence, trying to put China in a helpless situation. The strengthening of cooperation between the United States, Japan, and Europe in chips and semiconductor research can prove this.
In a word, compared with the policies adopted by former president trump, US President Biden's strategy in the field of technical confrontation against China seems to be shrewder and multilateral.
However, it all seems a little bit late. This is because China has realized that if the United States restricts the import of some key components and accepts OEM services for political reasons, China's chip industry will suffer a devastating earthquake. A sense of insecurity has been deeply rooted in the hearts of China's chip industry and the Chinese government. Therefore, it is imperative for China to develop its chip and semiconductor industries. Recent Chinese government policy support, financial support, and education support are good testimonies.
China seems to have a bright future, but then the question arises: will China's chip industry eventually surpass the American, European, and neighboring countries' markets and realize 100% domestic substitution? If so, how many years will it take?
The source of the gap
To solve these problems, the first step is to study the gap between China and the world. It is crucial to understand the current situation of China's chip industry and the development process of competitors.
Take the United States as an example. The chip industry originated in the United States in the 1960s. The main force supporting the semiconductor industry in the United States was the Department of Defense. At that time, the United States issued many policies to deeply intervene in all links of semiconductor research, which greatly promoted the development of the American chip and semiconductor industry. At this stage, although the American consuming chip market had begun to develop, it was not very prosperous. In the 1980s, Japanese and Korean companies represented by Toshiba, Panasonic, and Samsung rose in the chip field. More importantly, the semiconductors produced by Japan and South Korea under relevant policies were mainly for the consumer market, which has a great impact. In order to cope with the competition between Japan and South Korea, the United States turned to the 'no wafer' mode and chose to use its alliances' industrial chain to hold the light-asset and high-profitability design link itself while outsourcing manufacturing equipment, basic materials, and production to countries and regions such as South Korea and Taiwan. In this mode, the cost of chips designed by American semiconductor companies began to decline rapidly and finally won the competition with the Japanese semiconductor industry by dumping. The world has gradually formed the pattern of the world chip industry chain made by European and American design, and Korea and Taiwan OEM. However, in the process, due to political factors, the participation of the Chinese mainland is not high.
The main reason China's chip industry was stuck may be related to the 'import rather development' path of China in the late 1980s and early 1990s. Take the lithography machine, the weakest link in China's chip industry chain, as an example. In 1982, the KHA-75-1 lithography machine was produced by the Chinese Academy of Sciences Foundry 109, which was less than four years gap compared with the advanced machine from Canon at that time. In 1985, Institute 45 of the Ministry of Mechanical and Electrical engineering developed a prototype of a lithography machine, which reached the level of 4800dsw in the United States. However, in the late 1980s, China began to follow the 'import rather development' path, giving up independent research and development and blindly opening to the world market. Since then, China's independent scientific research and industrial systems have been destroyed. The industry has become an assembly foundry in terms of hardware, providing cheap labor for foreign-funded semiconductor companies. As a result, China had the 193nm ARF lithography project in 2002, but there was a more than 20-years-gap already behind ASML. The experience of other links in the chip industry chain is similar. At the same time, developed countries represented by the United States have completed industrial transfer and exported a large number of advanced chip products to China at low prices (similar to dumping), which further hit China's enthusiasm for independent chip research and development.
Now, if all parts made in China are used, China conservatively estimates that it can only independently manufacture 90nm chips, which leaves an incalculable gap with the world's advanced processes. Can China finally complete this crucial process (this is also the first problem to be solved in this analysis)?
Based on our research, we believe that China can finally catch up with and surpass neighboring countries, European countries, and the United States to realize a domestic-only industrial chain. There are many reasons.
1. Policy trend
At the policy level, the East Asia model is actually more suitable for chips. It is an industry that needs continuous investment. It is a strategic industry and is not suitable for market-oriented countries. The State Council has just issued a document to encourage the development of integrated circuit chips and related software industries. The document encourages all chip production and manufacturing links, including upstream chip equipment, design, foundry, materials, packaging, testing, and EDA software. For companies with chip processes less than 28nm, direct tax exemption for ten years will be imposed, and for key chip design companies, including EDA, the exemption will be imposed five years.
The US sanctions against ZTE and Huawei have suddenly turned the worries of Chinese people over many years into reality. In early June 2021, Huawei released the official version of the first operating system HarmonyOS and touched off a wave of domestic substitutes. Now, all important fields and industries, officially or unofficially, require domestic substitution, even if the price of domestic products is high and the quality is poor. On the one hand, this has reduced the impact of the European and American technology blockade to a certain extent. On the other hand, it has driven the performance of the domestic science and technology industry and driven the development of the upstream of the industrial chain from the downstream of the industrial chain. China's semiconductor industry is following a plan that holds that, by 2025, China's chip self-sufficiency rate will reach 70%. This has brought about a prosperous stimulation to China's chips market. SMIC's 78nm and 54nm production lines are saturated, and NAURA Technology Group's orders deliveries have been scheduled for 2023.
The investment cost of an 8-inch foundry is less than USD 1 billion. However, when it comes to 28nm nodes, the investment cost of each corresponding 12-inch foundry has soared to more than USD 10 billion. At the 5nm node level, TSMC's estimated investment is more than USD 25 billion per foundry. Such a huge demand for funds actually needs the joint support of the government and the investment field.
In September 2014, the China Integrated Circuit Industry Investment Fund (Large Fund) was established to support the development of China's semiconductor industry. At present, the funds have invested CNY 138.7 billion in over 70 effective investment projects, focusing on the integrated circuit chip manufacturing industry, taking into account chip design, packaging and testing, equipment and materials, and other industries. On October 22, 2019, Phase II invested CNY 204.15 billion to upstream material and wafer manufacturing companies. From that on, the Chinese government's supports have realized full coverage in the industry chain.
The VC/PE market in China's chip industry is also buoyant. According to the data of Winsoul Capital, the funding raised of the whole chip industry exceeded CNY 140 billion in 2020, of which 67.2% (about CNY 94 billion) were contributed by the chip design sector, in which many state-owned investors with high success rate participated. For example, the GPU design company Moore Threads (established in October 2020) has received financing of over CNY 1 billion from investors, including Shenzhen Venture Capital, Sequoia Capital China fund, and GGV Joint Venture.
3. Market and industry line
In December 2020, Volkswagen warned that due to the shortage of semiconductors, the company will encounter large-scale production interruption in the first quarter of 2021 and will adjust the production of factories in China, North America, and Europe at that time. After that, the shortage wave far exceeded estimates, and the production reduction effect is spreading among many industries around the world, including consumer electronic products such as mobile phones, tablets, game consoles, sensors, and MCU of cars. As we all know, the problem of this phenomenon mainly occurs in the manufacturing process, which is mainly caused by COVID-19 and the 5G devices change boom.
However, this phenomenon undoubtedly brings opportunities to China, especially the chip market in the automotive industry. Under the tide of shortage, the willingness of auto customers to use the domestic supply chain is increasing, which has promoted the research and production of some Chinese chip companies, such as Wingtech Technology. At the same time, these chip companies are also actively acquiring foreign advanced parts companies to shorten the research process. Wingtech Technology has acquired Nexperia and plans to build Lingang 12-inch foundry in 2022 to seize the opportunity brought by the shortage.
As we mentioned in our former article (check here), we think the talents will also be a significant driver in the process. In recent years, with the deepening of globalization and the change of population structure, we have observed that China's demographic dividend has been decreasing, while the talent dividend is increasing; this, we think, will be the new driver in China's new developing stage, a stage focusing on advanced manufacturing, especially the chip industry.
To sum up, based on the four aspects, we believe China will, finally, catch up with and surpass neighboring countries, Europe and the United States, to realize the domestic-only industrial chain. In the meantime, though the United States has been trying to obstruct the development of the Chinese chips and semiconductor market, we do believe the United States has lost its opportunity by giving up the 'dumping' strategy as it did to Japan – and China's government has been aware of the importance of chip industry's independent development.
After solving the problem of whether we can, the next problem comes to the length of time. First of all, to be clear, we strongly don't think China will do all of these things in five years. On the contrary, our estimate is 12 to 15 years, and the detailed reasons will be analyzed in the following article.
EqualOcean operates offices in Beijing, New York, and Shanghai. We welcome investors interested in the Chinese market to contact us via (contact@EqualOcean.com) or visit our offices. We believe the exchange of views will make you have a clearer prediction of the future.