We have been on a roller coaster ride of on again off again trade talk between China and the US. It is unclear where we are on a day by day basis but of late it appears that we are not seeing a lot of progress and some progress we thought we had made may not have actually happened.
We have two deadlines approaching that could outline how the US will proceed with trade and technology conflicts with China. On June 15th a $50B tariff list will be published and on June 30th the administration will unveil a larger plan of both trade and technology export controls.
A statement from the White House read;
“To protect our national security, the United States will implement specific investment restrictions and enhanced export controls for Chinese persons and entities related to the acquisition of industrially significant technology,“
We would safely assume that semiconductors and semiconductor equipment are industrially significant technology…….
Fish and Fishing poles…
It would seem to us to be stupid and illogical to stop exports of fish to an unfriendly country but still sell them fishing poles so they can lessen their dependence on us and therefore our leverage and advantage. In the semiconductor world how can we stop selling them chips, as in the ZTE case, yet still sell them equipment to make those same chips so they become independent of us ? This begs the question as to when we will see prohibitions on semiconductor equipment sales to China? There already has been restrictions on sales of semiconductor equipment to China that has kept them in a trailing position but these have loosened over the years.
China has recognized the existential threat to its technology and has publicly doubled down on its goal to get semiconductor technology ( See recent comments by Tencent head…)
We think there is a risk, however large or small, that semis and especially semiconductor equipment could be put on a “bad list” on June 30th by the administration. Wether it ever really gets implemented or not the risk to stocks is clear….those companies/technologies on the “bad list” will get whacked.
One step forward, two steps back…
It looked like we were making progress on trade but meetings in China seem to have come up empty so we seem more likely heading to a show down. This could obviously all be a “game of chicken” writ large on a global scale of hundreds of billions of dollars in trade. Right now both sides are on a path to a larger conflict until one side blinks….or not.
We thought we had a good outcome on ZTE but now it appears not….
We thought we had a good decision on QCOM & NXPI but that is stalled again. In short we have no real progress on trade with China and lacking that we seem to be moving ahead with escalation of the problems through offensive sanctions and tariffs.
ASML and EUV on the “bad list”?
It is little noticed, and low profile, perhaps on purpose, that an EUV tool was ordered recently by SMIC , China’s largest fab company, from ASML. This is exactly the type of technology that is at the heart of the trade technology issue.
Without an EUV tool, China would be permanently banished to the trailing edge of the semiconductor industry. With EUV they can keep up with the 3 chip titans, Samsung, TSMC and Intel.
In our view there are many reasons why ASML and EUV could be a target and test case of China trade sanctions.
EUV is already on the “bad list”
There exists little known, outside of the industry, the BIS (the Bureau of Industry and Security) part of the US Department of Commerce. “Where Industry and Security Intersect”…..
BIS is the actual government agency that stopped ZTE sales....
They maintain a list, much like Santa, of which technologies are naughty and nice and what can and can’t be exported to bad actor states. Semi equipment has already been on that list and more specifically EUV……
f. Lithography equipment as follows:
f.1. Align and expose step and repeat (direct step on wafer) or step and scan (scanner) equipment for wafer processing using photooptical or X-ray methods and having any of the following:
f.1.a. A light source wavelength shorter than 193 nm;
or f.1.b. Capable of producing a pattern with a “Minimum Resolvable Feature size” (MRF) of 45 nm or less;
The White House doesn’t need to put together a list for June 15th and June 30th, as it already has one…….
ASML is “perfect” political choice…
The prohibition of sales of chips to ZTE negatively impacted US companies and jobs, specifically Qualcomm, Lumentum, Google (software) even Intel and others. Blocking ASML sales to China would not directly impact a US based company (and its associated Republican congressman as is the case with QCOM). It would not impact ASML (former Cymer) employees in San Diego as they are needed for all other ASML customers. The Netherlands is probably low on the administrations radar (even if found on a map…).
In short ASML EUV sales are a politically perfect target and pawn in the trade wars.
No immunity….Collateral Damage?
In case you thought ASML is immune or not part of the trade war between the US and China, just ask Aixtron , in Germany, whose sale to a Chinese company was blocked by the US department of defense and CFIUS.
The US has long arms that reach outside of its borders. In addition, the US could obviously be concerned with “industrially significant technology” inside US borders, such as the laser light source for EUV designed in San Diego. This is the heart and soul of an EUV system.
That technology had its genesis in Ronald Regans “Star Wars” laser based defense technology. When the program was cancelled both US and Russian laser scientists found their way to little know (at the time) Cymer in San Diego (the Russians liked the warmer climate….)
Seems like a “poster child” of technology that you wouldn’t want to export to China…….
Wassenaar, the Netherlands
In a funny coincidence, there exists a 42 nation agreement limiting technology sales to bad actor states, that originated in 1996 in Wassenaar, the Netherlands. The US and the Netherlands are signatories (China obviously is not…). The “Wassenaar Arrangement on Export Controls for Conventional Arms and Dual-Use Goods and Technologies” limits sales of dual use goods and could be used another arrow in the administrations quiver in its China trade war. This agreement could be used for further leverage by the US.
US companies not immune to fallout…
The administration could also directly add US companies to the “bad list”, such as AMAT, KLAC and LRCX etc;, although it may be politically distasteful (not that the administration cares…). AMAT has a huge operation in China and has been doing business there forever. With 15 or more fab projects in China there is a lot of equipment to be sold.
Its equally hard to stop chip sales let alone chip equipment. Intel has a large operation in China and does a lot of business there. Lets not forget that BK of Intel was a huge Trump supporter and probably on the friends of Trump list.
We think it would be very hard for there to be meaningful trade sanctions against China unless US chip companies were involved and thus negatively impacted.
Stock Impact and “Headline Risk”
Although its less clear what the long term impact will be in US, China trade war and whether or not things will be worked out in the end, as they usually are as its in the best interest of both parties. However there is a huge amount of “Headline Risk” going into June 15th and June 30th. We see virtually no upside coming out of those dates and large downside. The best that can happen is nothing happens and the can gets kicked down the road or something similar.
There is a virtual certainty that US tech companies will be negatively impacted and that semiconductor companies will be front and center in that impact.
We would be light on some of the chip companies stocks and maybe some select tech names. Since we don’t know which companies will be impacted and how much it may be better to do a broader bet and be short the SOX or other tech index going into those dates.
Longer term investors will likely weather the impact of those dates but there may be short term trades, based on the volatility, such as straddles, that can make money.
Our April fools joke about Trump halting chip equipment sales looks more real every day. Fake News or Real News??? Can’t tell the difference anymore…….