Could loss of SMIC lead to loss of most of China?

Is the US finally getting truly tough on China? or just a bluff?
Could lead to a global reset of the industry & 10 year retreat?
Tech stocks wings have melted after super heated stock run?
SMIC added to the “naughty” list?

There have been numerous reports that the US is considering adding SMIC to the China “naughty” list of bad actors linked to Chinese military or defense related industries.

Trump administration weighs blacklisting China’s chipmaker SMIC

This is obviously a continuation and escalation of the tit for tat trade exchanges between the US and China. Huawei has so far been the focal point and star of the show having taken over from the opening acts of ZTE and Jinhua.

It is an important escalation as someone in Washington has finally figured out that stopping China from buying chips also means that you have to stop selling them equipment to make chips….. duh!!!

It s also naive to assume that China would never use its most advanced fab to make chips with non-civilian use cases. Just where do all the chips in China’s latest military equipment come from?…the tooth fairy? TSMC? SMIC? Lets get real. You don’t need some Washington think tank (SOS International) to figure that out….

U.S. Weighs Export Controls on China’s Top Chip Maker. Will the ban spread beyond SMIC?

We think its safe to say that because SMIC is the most advanced of China’s native fabs , it is at the top of the list to go after. Such as stopping the shipment of an EUV scanner.

But it is also equally as clear that there are a number of Chinese memory fabs that are quite advanced, though lesser known, that might get on a list.

We think its a safe bet that SMIC is just first on a long list of perhaps most if not all of China’s new, domestic fabs.

The ban may not spread to fabs owned by non Chinese firms such as Intel or Samsung etc, but then again , those fabs are by design not at the leading edge.

Foundry makes sense to ban first as it would be a replacement for TSMC capacity and potentially try to keep Huawei limping along in business.

China is up to half of Semiconductor Equipment business

Unless you have been asleep for the last ten years, China is the fastest growing market for semiconductor equipment as well as the largest market for most equipment. Although spread over a larger number of customers as compared to Korea (Samsung) and Taiwan (TSMC), China is still huge.

SMIC recently raised $7B in a public equity offering which is on top of $2B raised from the Chinese government in the spring. The vast majority of that $9B was likely going to purchase semiconductor equipment (maybe some facilities), with most of that likely purchasing US made equipment.

The percent of business which China represents for US equipment companies is anywhere from a quarter to a half of business with most being at the upper end of the range. This means that the loss of China business could be devastating and set semiconductor equipment companies back almost 10 years to when China started its huge investment run a while ago.

We don’t see Japan coming back as a huge force in semiconductor manufacturing nor do we see the US on a comeback path, especially after Intel announced its “fab lite” model to outsource more manufacturing to TSMC.

A “cold turkey” cut off could be very ugly

If the US government decided to cut off SMIC cold turkey, things could get very ugly, very quickly. Much like Jinhua we would have to assume that the government would also cut off support of existing installed equipment as well, which would cut off recurring revenue as well.

At Jinhua, US companies employees left literally in a day and were on the next plane out leaving the fab in a lurch and killing it in 24 hours.

Without spare parts, maintenance and upgrades SMIC would have serious problems continuing to function.

So much as with ZTE, Jinhua and Huawei, denying access to US technology could prove a death sentence for SMIC.

Not much political leverage

As we have pointed out many times over the last several years, semiconductor and semiconductor equipment makers are primarily headquartered in California, which the current administration could care less about….well maybe not less than the Netherlands (ASML).

As we get closer to the election, more aggressive posturing is likely, which would include that “no one is as tough on China as us”, to increase election odds.

The administration could easily cut off SMIC in front of the election only to open it back up based on some new trade deal afterwards. Getting tougher on China will only increase much needed votes.

No easy way out

There is no easy way out of the situation. The administration has put itself in a corner it can’t back down from without looking weak on China at a bad time. Technology is one of the few leverage points the US has, especially in semiconductors and it likely needs to use it as it has run out of levers to pull.

We think the situation will get bad the only question is how bad and how quickly. With time pressures on we could get an announcement soon.

Tech stocks and Icarus…flying to high…then melting

Tech stocks and especially semiconductor stocks have been on fire all through Covid as a safe refuge due to the work at home economy and need for laptops and servers.

We have been suggesting and warning that this could see a poor end once the initial flurry of buying cools down to the reality of unemployment and an ugly holiday season.

There has already been noise of weaker memory demand/pricing looming. One of our biggest concerns is that the threatened cut off of Huawei has generated a storm of buying, hoarding and stocking up in front of the drop dead date. Which we think has created a false sense of demand that many investors have viewed as 100% real.

The Scramble for Chips

Hong Kong Chip route cut

Huawei will have a lot of inventory to work down but will need it. So far, non Huawei demand is very strong at TSMC and will likely fill any near term void but perhaps not forever. Right now TSMC is in good shape as it ramps for its biggest customer, Apple , and their latest release, but after that???

The Icarus effect…Tech stocks flew too high

Tech stocks have gotten over inflated during Covid as money looked for a safe haven from the Covid fallout, and as today’s stock action noted the air may not come out of them slowly but rather suddenly as investors figure out that even tech is not safe as SoftBank and now SMIC may be only be the beginning.

As is usually the case, sub suppliers such as AEIS, UCTT and ICHR are the hardest hit and most volatile with each being off over 10% today. KLAC and AMAT with high Chinese exposure were down 9%, along with LRCX.

SMIC and Huawei related fears could be the catalyst for a correction in chips, especially if we get confirmation of the administrations potential actions.

Although we could also get a dead cat bounce here we think its safer on the sidelines as at the very least it will be volatile for a while and we don’t see nearly as much upside as we see downside here as it could get uglier still….

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