We have been watching the ZTE saga play out on the public stage as we think it is an extremely important leading example of how the administration will truly act. As we all know, actions speak louder than words, and in the case of ZTE our words said one thing and our actions said something else. We need to analyze what the actions really mean about trade issues that impact technology and China as ZTE was perhaps both the first real test as well as the poster child for China trade issues.
ZTE impacts both companies selling semiconductor components to ZTE and obviously ZTE itself. However, the true impact is much broader as it is an indicator of other semiconductor companies who sell into China, semiconductor equipment companies who sell into China as well as IP issues and many other far reaching issues.
There has been a cloud hanging over a large swath of semis as China sales are the fastest growing area of business for most companies and represents much, if not all of the future upside.
From a stock perspective, we have been very concerned about the downside risk to US tech companies if the US got into a real trade war with China. We were only partially kidding about our April fools note which jokingly announced a halt of US semiconductor equipment sales to China. We think it could happen but now the likelihood has been greatly reduced following the ZTE surrender.
Additionally, the Washington Post has printed a list of “demands” from China regarding trade. We now have a yardstick to judge the administration by as we can see which of the demands we have caved in on.
ZTE = Zhilaohu (paper tiger)
The term “zhilaohu” or “paper tiger” was coined by Mao Zedong to describe the US as being all bark and no bite. It would seem that we could resurrect that term to describe the current situation with trade as it applies to ZTE.
Hollywood screenwriters could not have dreamed up a more perfect nemesis for the current administration than ZTE.
- More jobs in China versus US – check
- Supporting Iran by providing equipment – check
- Supporting North Korea by providing equipment – check
- Suspected of espionage in equipment – check
- Poster child for trade dispute – check
ZTE checks all the boxes and the administration could claim victory on so many fronts so it seemed like a slam dunk until we caved. This is why everyone is spinning.
The press has drawn a dotted line to a Trump company deal in Indonesia that will feature a Trump branded hotel, residences and golf course, being built with $500M from the Chinese government.
Some have suggested the US caved over concerns of agriculture exports to China being at risk.
Whatever the real story is, its confusing. The official US stance of saving Chinese jobs just doesn’t seem to hang together.
The Chinese “Demand List”
The demand list from China as published by the Washington Post;
- The United States commits to eliminating the sanctions imposed after China’s crackdown on protesters in Tiananmen Square in 1989.
- The United States relaxes export restrictions on technology such as integrated circuits- Read this as China can buy all the US technology it wants, good for US chip equipment makers bad for competing chip makers who could get trashed like solar and LED before them.
- The United States allows U.S. government agencies to purchase and use Chinese information technology products and services- Goes against concerns of trojan horse firmware in Chinese equipment- routers and mobile phones.
- The United States agrees to treat Chinese investment and investors equally to those from other countries and place no restrictions on Chinese investment –Would allow Chinese purchase of Lattice, Xcerra or Micron or many other US tech companies.
- The United States agrees to ensure Chinese businesses can participate in U.S. infrastructure projects Allows suspect equipment and companies to be used in critical US infrastructure.
- The United States agrees to strengthen protection of Chinese intellectual property. Means companies like AMEC will win over companies like Veeco. US IP protection would be zero.
- The United States agrees to drop its anti-dumping cases against China at the World Trade Organization. China would be allowed to dump in the memory chip business just as they do in solar and LED.
- The United States agrees to terminate its investigations into Chinese intellectual property theft and not impose any of the sanctions Trump already announced. China is free to rip off any US IP.
By any standards this is a pretty ugly list. We now have a very public yardstick to measure future US trade deals and can grade the ZTE reversal as an “F”
Removes the sword of Damocles
We have been concerned about the risk of a major event in the trade tirade with China. We have been concerned of halting chip sales or equipment sales or other things that could trash US tech stocks.
Given what happened with ZTE it is very clear that the probability of getting into a real trade war with China is near zero and all we will do is likely to be lip service.
People can point to CFIUS blocking several deals but the reality is that the biggest blocked deal was Broadcom buying Qualcomm and it was not directly against a Chinese company. The Lattice deal was blocked but probably would have been blocked for any foreign buyer.
The administration seems to be against most any large deal not just foreign companies buying US companies.
Maybe next years April fools article will be giving advanced chip tools & designs away free to China……
In our view while there is no specific upside to be had in US stocks other than those directly involved with ZTE which have already popped.
In our view, risk to US semiconductor and equipment sales has been greatly reduced, perhaps not to zero, but to levels similar to what we had prior to the trade tirade.
The longer term threat to IP and technology dominance still remains and could get worse depending upon how the US responds to China’s demand list.
For now, at least another variable has been removed or reduced from an already volatile tech sector.
This could obviously change at any moment and we could see yet another 180 degree reversal from the administration so we wouldn’t get too comfortable.
Perhaps the administration is listening to cooler heads in the tech industry like Tim Cook , but we doubt it…….
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