PRINT THIS PAGE When the chips are down22/06/2005. Source: Asian Private Equity Review.
China's semiconductor industry, especially SMIC, faces more than a cyclical downward trend at a time when global demands for chips slow, says the Asian Private Equity Review. The global semiconductor industry had a good year in 2004. Sales grew 28% from 2003 to reach an historical high of US$213 billion. According to the Semiconductor Industry Association ('Association'), it was also the first time since 2000 that sales had broken the US$200 billion mark. There are signs however that a new cyclical downturn is bearing down on the industry.
The Association cautioned that adjustments are taking place in the face of declining demands. The orders posted by semiconductor equipment makers in February stood at US$1.03 billion, down a chilling 22% compared to the same period a year ago. Infineon Technologies AG, Europe's largest semiconductor manufacturer, also reflected the cooling climate for the sector when it reported a larger than expected loss of 114 million Euro (US$148.1 million) compared with a net profit of 39 million Euro a year earlier.
Information technology research house, Gartner Inc. forecasted a 15.3% decline in sales of chip capital equipment in 2005, compared with 56% growth in 2004. It expects growth to return in 2006 but cautions that this could easily change. (fig.4)
In the twenty-one quarters ending March 2005, Asian private equity investors have committed over US$4.6 billion to the semiconductor industry, of which China accounted for 54.3%, or US$2.5 billion (fig.5a). The amount pledged by investors to China's foundry business has been an overwhelming display of confidence on the future prospects of this industrial sector which has enjoyed an annual growth rate of 30% over the past five years. Since 2000, China has attracted US$6 billion of foreign private equity (fig.5b).
The semiconductor sector accounted for 41.8% of that total in nine separate companies (fig.6).
Indeed China's economic growth has altered the landscape of the global semiconductor market. The world's most populous nation has advanced to become the third largest semiconductor market, after USA and Japan. In 2004, the USA, once the biggest market for semiconductors, accounted for just over 18.3% of global sales whereas sales in the Asia Pacific region (excluding Japan) commanded a staggering US$88.7 billion or 41.7% of the global sum.
The amount represented a surge of 41% compared to data in the preceding year. A key factor in this rapid rise for the Asia Pacific region was China which saw its sales reach 290.8 billion yuan (US$35.1 billion) in 2004, or 16.4% of the US$213 billion of the global total.
Despite the onset of cold winds blowing across the global semiconductor industry, Beijing is unlikely to waver and has gestured its determination to propel its nascent yet burgeoning local industry. Fresh from settling a landmark dispute with the US government, China is considering other initiatives to fuel the growth of its semiconductor sector.
In December 2002, the Association, whose members include industry heavyweights Intel, Micron Technology and Texas Instruments, claimed that China was violating the World Trade Organization rule by providing rebates on value-added-tax ('VAT') to local manufacturers, resulting in an estimated US$340 million loss of revenues to US-based manufacturers. After formal complaints by the US, China terminated the VAT practice early this year but is looking to implement other initiatives to support the sector.
These include an extended tax holiday for companies in the sector and funding support of up to half of semiconductor related research and development costs. In addition, Beijing is considering a fund of up to 1 billion yuan (US$60.4 million - US$120 million) that will provide infrastructure assistance to local manufacturers, as well as an additional fund to support the skill development of industry specialists.
China's relentless drive to fuel the growth of its semiconductor industry during the past decade has sown seeds of fear in rivals, particularly those in Taiwan.
Much of this can be witnessed in the turbulent journey experienced by Semiconductor Manufacturing Industrial Corp ('SMIC'), China's largest foreign-owned foundry. As a five year old company, it has encountered more than its fair share of tests.
Established in 2000 and seeded by both H&Q Asia Pacific and Walden International, SMIC enlisted a prestigious list of private equity investors, including Goldman Sachs, Temasek Holdings and New Enterprise Associate. Globally SMIC is making strides in expanding its market share. In 2002, its sales stood at US$50 million, representing 1% of the market but by 2004, the figure had surged to US$1.03 billion or a 6% share of the total.
Domestically, SMIC is positioning itself to capture a 15% of local semiconductor pie in 2005, up from 10% in 2004. While SMIC still dwarfs global leaders such as Taiwan Semiconductor Manufacturing Corp ('TSMC'), which generated US$7.65 billion in sales in 2004, it has nonetheless impacted TSMC's market share. The world's largest chip maker's global market share was estimated at 47% in 2004, down from 54% in 2002.
With growth posing threats to its rivals, SMIC has encountered obstacles potentially slowing its rapid pace of development. Months prior to its initial public offering ('IPO') in March 2004, two Taiwan-based venture capital firms, Prudence Capital Management and Global Strategic Investment Funds, had to cancel their funding commitments to SMIC as the island prohibited direct interest by Taiwanese companies in this industrial sector. The man behind Prudence Capital is Mr Hsu Li-Teh, former the premier of Taiwan.
The next obstacle that arose, just weeks before SMIC's public debut, was legal action initiated by TSMC over alleged patent infringements and poaching of its staff. The shadow of the looming court dispute dimmed SMIC's listing performance, which saw its share price plunge 8% on its first day of trade on the Hong Kong Stock Exchange ('HKSE'). The legal dispute was settled recently, with SMIC ordered to compensate TSMC a total of US$175 million.
As if rivalry from TSMC were not enough, SMIC also faces challenges from another operator from across the Strait. In March, United Microelectronics Corp. ('UMC'), Taiwan's second largest semiconductor manufacturer, disclosed that it had been providing strategic advice to China's HeJian Technology Ltd. ('Hejian').
The latter was formed in 2001 and received over US$1.5 billion from a consortium of investors, including Singapore's Economic Development Board, Japan's Softbank Inc. and NIF Ventures. As UMC's involvement in HeJian came to light, Mr Robert Tsao, chairman of UMC was unreserved in admitting his attempt to thwart SMIC's growth by supporting Hejian, SMIC's potential rival in its own backyard.
Most recently, SMIC's anchor man and president, Mr. Richard Chang discovered that despite being a US citizen he was not about to receive any favours when it came to seeking support from the US Export-Import Bank for a loan guarantee. SMIC was ultimately turned down for the guarantee which was for proposed equipment purchases from a US supplier.
In the end, the company had to turn to Japanese financial institutions to resolve financing for its equipment investments. At the same time, the Taiwan government fined Mr. Chang who was born in Taiwan, for unauthorized investment in China and demanded the withdrawal of his financial commitments in China within six months. Although the penalty was only NT$5 million (US$159,000), it was nonetheless another attempt to hinder the potential threat posed by both Mr. Chang and SMIC.
Observation
Coinciding with the down trend in the chips manufacturing industry, SMIC announced its second consecutive quarterly loss. For the quarter ending December 2004, SMIC reported a net loss of US$11.2 million. This jumped to a net loss of US$30 million for the three months ending March this year, an increase of 267%. On the HKSE, SMIC's shares currently trade at 48% below their listing price of HK$2.69 each, paid by investors just 14 months ago.
SMIC's plight highlights the escalation of global rivalry as China's semiconductor industry scales new heights. With this in mind, the nascent China semiconductor industry, which looks to SMIC as its leader, has all the reasons to lean on Beijing's support in order to weather the current slump.
Asia Private Equity Review (APER) is the foremost voice on matters related to private equity/venture capital in the region. Well-recognised as being the singular source for accurate and timely news, in-depth analysis and global perspectives, APER is published by the Hong Kong-based Centre for Asia Private Equity Research. For further information please visit their website at www.asiape.com or email them at info@asiape.com
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