Introduction - IC Industry Building Capacity
China is the world’s largest semiconductor consumer, whose market demand far outweighs its manufacturing capability. To narrow the production-consumption gap and build up overall capabilities, overarching policy papers such as National Integrated Circuit Industry Development Outline (IC Outline) and "Made in China 2025" (MIC 2025) were published, aiming at full self-sufficiency. We have since observed a number of trends in the industry, including increased overseas investments, partnerships, capacity surges, product range diversification, and the rise of original equipment manufacturers (OEMs) developing their own integrated circuit (IC) designs.
Already a strategic industry in China, the semiconductor industry is deeply tied to the country’s electronics manufacturing industry. Gartner predicts China to be responsible for 38% of the world’s electronic equipment production by 2017 end, while the semiconductor component of that production is expected to gradually rise to over 35%. Semiconductors are also the enabler and early indicator of all emerging information technology sectors, including Internet of Things (IoT), cloud computing, big data, AI, autonomous driving, electric vehicles (EV), robotics, 3D printing, LED, powered electronics, aerospace technologies, and medical devices. Most of these segments were identified as key development areas in MIC 2025, with supportive five year plans laid out by Ministry of Industry and Information Technology (MIIT) and State Council.
Current Dynamic - Six Things To Pay Attention To
1. Supply-Demand Mismatch
China’s semiconductor industry distinguishes itself by its sheer market size and the noticeable gap between domestic supply and demand. Based on PwC statistics, semiconductor consumption in China in-creased at a 14.3% com-pounded annual growth rate (CAGR) between 2005 and 2015, with the domestic market representing 58.5% of total global consumption in 2015. The country’s production capacity, however, remains seriously lacking.
At its best, China’s IC production / consumption ratio stood at only 33% in 2015. This lopsided production deficiency has made semiconductors China’s largest import, even surpassing crude oil. The main driver of China’s IC consumption has until now been mobiles electronics, while recently, demand pull is also coming from emerging sectors such as IoT.
Sub-sector wise, both IC and optoelectronics sensor discrete (OSD) industries grew steadily in the past decade. For IC industry, revenues from design, manufacturing, as well as testing and packaging posted respectively 30%, 17.6%, and 18% CAGR between 2005 and 2015. The O-S-D industry saw a slower ten-year CAGR at 15.6%.
Nevertheless, China’s IC design capabilities are considered relatively lackluster, when compared to its peers in the United States, Taiwan, South Korea, and Japan on process technology and product line breadth, and rely heavily on foreign design tools and software suppliers, while licensing significant intellectual property (IP) from other firms.
In terms of manufacturing, apart from the capacity gap, Mainland Chinese IC fa-brication labs are considered to be at least two generations behind the market leaders on process technology and wafer size.
2. IC Outlines and MIC 2025
Prior to the introduction of IC Outlines and MIC 2025, China’s semiconductor industry was driven mostly by state-led, top-down incentives that did not actually trickle down, and resulted in a highly fractured industry landscape. In its second try, policy makers are now taking a market-driven approach where the government functions as facilitator rather than planner.
After laying out the main objectives in its overarching guidelines, regulators launched supplementary policies, investment funds, and a task force to smooth the further development of the IC industry. Issued in 2014, IC Outlines set industry targets for 2015, 2020, and 2030. By 2020, China’s annual IC output growth is targeted to reach 20% CAGR, delivering world-leading IC production capabilities in smart mobile devices, network communications, cloud computing, IoT, and big data. While by 2030, a group of Chinese firms across the IC value chain will grow to be top players in the global market. A major focus is to facilitate regional firms becoming national champions.
To support this initiative, National IC Industry Investment Fund (colloquially known as the “big fund”) and some local level funds, managed by PE firms, were established to finance partnerships, joint ventures, and M&A activities. The big fund has a five-year investment deployment target of roughly RMB140bn, and the state is currently planning on its second and third phases, while making detailed investment plans in semiconductor sub-segments. A special task force, the National IC Industry Leading Group, was also set up in 2015 to coordinate between different entities and streamline decision making.
In 2015, State Council issued MIC 2025 which formalized semiconductor design and production as a key information technology industry, emphasizing IP, design tools, test and packaging capabilities, and foundry equipment supply. The goals include achieving a 40% self-sufficiency ratio in IC production by 2020 and 70% by 2025. And unlike IC Outlines which highlights mobile devices and production, as global consumption flattens, the na-tional strategy since the 13th Five-year Plan has expanded to cover memory, analog, and compound semiconductors. These semiconductors are being pushed for to support consumer end-markets such as connected cars, advanced manufacturing technologies, big data, network communications, LED, powered electronics, and avionics.
3. Growing Overseas Appetite
The past two to three years witnesses China buying its way into global semiconductor industry. Chinese chip-makers have launched a slew of overseas bids, some very high-profile, to acquire foreign IP and boost manufacturing capabilities. Often times, these overseas activities are backed by state-led vehicles set up solely for IC industry development purposes.
Many of the recent deals were, however, met with political obstacles due to the rising foreign vigilance against China-backed acquisitions. In December 2017, Fujian Grand Chip had to drop the EUR670m bid for German semiconductor equipment maker Aixtron SE, after U.S. President Obama blocked the takeover of Aixtron's U.S. subsidiary, following suggestions from the Committee on Foreign Investment in the US (CFIUS).
In January 2017, the U.S. President's Council of Advisors on Science and Technology (PCAST) issued a report that identified China’s industrial policies as posing real threats to its own domestic semiconductor innovation and U.S. national security, and called on protecting sectors considered critical to national security. The report also includes CFIUS guidelines, which are likely to further heighten scrutiny of Chinese investments in the U.S. semiconductor sector.
Another approach that is often employed by Chinese firms to obtain foreign technology is to form joint ventures or license IP, sometimes forcibly through discriminatory regulations and laws. Foreign companies, which in recent years have become heavily dependent on China for revenues, would often agree to transfer technology or form a JV in exchange for market access and market share.
As key examples, Dutch-based NXP Semiconductor partnered with Chinese automaker Geely on auto telematics R&D in January 2017; Taiwan-based UMC struck a partnership with Fujian Jinhua Integrated Circuit on DRAM process technology R&D in May 2016; Qualcomm formed a JV with Huaxingtong Semiconductor Technology in January 2016; Wuhan Xinxin Semiconductor Manufacturing Corporation (XMC) partnered with U.S. flash-memory maker Spansion in 2016.
4. Capacity Boost
We have seen a ramp-up of large-scale wafer plants being built in the country over the past three years to close the supply-demand gap. In November 2016, Huali Microelectronics (HLMC) announced the construction of an RMB38.7bn 300mm (12-inch) fabrication plant in Shanghai. While In October 2016, Semiconductor Manufacturing International Corp (SMIC) also said it would invest USD10bn in a new 300mm wafer plant in Shanghai.
Overseas companies operate advanced fabs in China as well. Most recently, California-based semiconductor manufacturer Global Foundries announced its plan to build a 12-inch wafer plant worth USD10bn in Chengdu. According to semiconductor trade association SEMI, between 2017 and 2020, China will see 26 facilities and lines commence operations, roughly 42% of the worldwide total. Research firm IC Insights predicts that 20.9% of all chips manufactured globally will be made in China by 2020, compared with 12.7% in 2015.
• Case study: Tsinghua Unigroup
Tsinghua Unigroup features prominently in China’s semiconductor ambition, with its every movement echoing national strategies. In 2013, the SOE acquired Shanghai-based Spreadtrum for USD1.7bn as it ventured into IC industry. In 2014, it bought out RDA Microelectronics for USD910m.
Tsinghua Unigroup Chairman said in 2015 the firm planned to invest RMB300bn over the next five years to become world's third-largest chipmaker. One year later, it invested in foreign chipmakers including Lattice Semiconductor and Marvell. After several unsuccessful bids for Micron Technology, Western Digital, and a few Taiwanese firms, Tsinghua sought to form cross-border partnerships to navigate around politics and obtain its coveted technology.
Tsinghua-backed Unisplendour set up a joint venture with Western Digital called Unis-WDC Storage with USD158m in Nanjing in September 2016. And shortly following its merger with XMC in July, Tsinghua successfully obtained the 3D NAND technology licensing from Micron. In December, it sought control of its JV with XMC, Yangtze River Storage Technology, for RMB19.7bn, to expand production capacity. The chip behemoth later signed a memory chip project worth RMB260bn in Nanjing, another RMB200bn project in Chengdu, and broke ground on its USD24bn 3D NAND plant in Wuhan.
In terms of research, Tsinghua pledged RMB50bn in R&D investment over the next five years on strategic technologies from 2016. In 2015, the firm spent RMB6bn in R&D, representing 9% of its revenue, according to a company spokesman.
5. Diversifying Product Mix
Traditionally, China has focused mainly on the design and manufacturing of logic and mixed-signal ICs used in mobile devices. Since MIC 2025, more efforts are being channeled into R&D and manufacturing of analog chips (for robotics, smart cars, EV, IoT, and smart grid), memory chips including both DRAM and 3D NAND flash memory, and compound chips (for LED and powered electronics). In April 2016, MIIT released its Implementation Plan for the 2016 Industry Strong Base Special Project, which pushed for powered and passive semiconductor development, and encouraged lenders, VC firms, and funds to support the sector.
6. OEM IC Design Ambitions
Aside from semiconductor firms, original equipment manufacturers (OEM) such as Huawei, ZTE, and Xiaomi, are also accelerating their chip design efforts to reduce reliance on overseas suppliers such as Qualcomm and MediaTek. Huawei, via its subsidiary HiSilicon, has launched several mobile products powered by its in-house “Kirin” chips. Xiaomi also introduced its self-developed “Pinecone” processor, and incorporated Pinecone processors in some of its lower-end models.
The Future - Key Trends
1. Short Term: Acquisition, Partnership Push
In light of heightened political hurdles, especially from Germany, the U.S., and Taiwan, we expect fewer overseas M&A and investments to succeed compared to previous years, especially in sensitive product segments, such as CPU, GPU, digital signal processors and high-end memory chips. As a result, cross-border partnerships in these segments will carry on, including new and continued JVs and technology licensing.
However, this will not translate into a sated appetite for overseas assets. On the contrary, China will continue pushing for overseas M&A, and buying sprees are likely to persist in less politically-sensitive segments. Shanghai Foundry SMIC, for instance, has disclosed its intention for another overseas acquisition after its LFoundry buyout. Unigroup Guoxin halted trading of its company stock on February 20, as is customary, citing a forthcoming major acquisition for overseas semiconductor assets.
2. Medium Term: Domestic Consolidation
Against a backdrop of rising costs and stagnant growth, the global semiconductor market is transitioning through a major consolidation in recent years, and we expect, in the medium run, that China’s IC market will also experience consolidation to save costs and leverage synergies. Greater foreign scrutiny on deals will also steer M&A attempts back home.
At present, China’s semi-conductor industry is still highly fragmented, with a large number of small, relatively similar players. According to China Semiconductor Industry Association (CSIA), the number of IC design firms in China increased from 736 in 2015 to 1362 in 2016, up 80.1%. That being said, the high-profile merger between Tsinghua Unigroup and XMC IC units is a sign that domestic M&A activities may be on the rise. In February 2017, Beijing-based memory designer GigaDevice announced plans to acquire a 100% stake in Beijing Xicheng Semiconductor.
3. Long Term: Home-grown R&D Efforts
In the long run, we believe more attention and capital will be channeled into domestic R&D, including HR incentives to not only acquire, but also retain talent, while encouraging innovation. Over a longer time horizon, China’s strategy to copy, partner, acquire and license foreign technologies will prove unsustainable. Currently, domestic designers, including HiSilicon, Spreadtrum, RDA Microelectronics, still trail far behind global industry leaders.
This capabilities gap, difficult as it is for current players, has given market latecomers a distinct advantage. Recent upstarts are leapfrogging older technologies and diving directly into leading-edge segments such as 3D NAND memory without having to invest in older NAND technologies. Case in point, recently in February 2017, Chinese Academy of Sciences (CAS) announced major breakthroughs in 32-layer 3D NAND memory chips, pioneered as a result of a research project undertaken by Yangtze River Storage Technology.
What To Watch:
1. Policies and Players Working in Concert
• Look for “MIC 2025” themed policies from Chinese policymakers that touch upon foreign investment and market access, beginning with overtures on bilateral innovative cooperation. Examples of this include China-German (and -Swiss) partnership to align MIC 2025 with “Industry 4.0”.
• Collaboration with other semiconductor heavyweights such as Silicon Valley in the U.S. may require further deliberation, given the current prickly environment that deals must navigate through, before closing.
2. Maturation of the Domestic IC Industry
• Short-term: Chinese semiconductor firms will continue to bid for overseas platforms that provide advanced technology and IP, but many deals will not be successful. Partnerships and JVs with foreign firms will thus continue.
• Mid-term: A highly fragmented domestic semiconductor market will mean that consolidation will pick up pace, driven not only by the need to cut costs and capture more market marketshare, but also due to a lack of successful M&A deals overseas.
• Long-term: Domestic semiconductor firms will eventually catch-up to global rivals, and the gradual build-up of R&D talent will bear fruit in the form of industry leading innovations. Latecomers will often enjoy a distinct advantage, given that they are not shackled by older technologies and manufacturing processes.