Beyond the STARs: Meet Overhyped Young China's Chipmakers
Four semiconductor companies – AMEC, Anji Technology, Espressif Systems and Montage Technology – successfully went public on the Star board this week. What’s behind their crazy valuations?
The SSE (Shanghai Stock Exchange) Sci-Tech Innovation Board, known as Star Market, finally opened for business this Monday, facing an insane demand jacking up the share prices that initially were quite high per se. At the end of the first trading week, all the 25 companies got their stocks bloated.
The current situation is apparently unhealthy and it is almost certain that the real value is way below the figures we are observing. The market is chaotic and might crack any time, triggered by the countless amateur investors that behave irrationally.
"Let the Star board be a bubble, then let it burst. That could be a first step in the way to a more mature financial market in China."
Wayne Shiong, partner at China Growth Capital
Although individuals with less than two years of trading experience are not allowed to invest on the Star board directly, it doesn't seem to be an insurmountable barrier for them: there is always a friend of a friend that may help. Apart from that, the number of low-qualified but "experienced" investors is historically high in China, a country of almost 1.4 billion individuals with a frail social welfare system. The local rule is simple: retirement is one's own issue.
Chips in the stack
Despite the inherent volatility of mainland China markets and sky-high valuation of the first batch of tech firms that went public on the Star board, there is a category of companies that, due to a plethora of factors, look flexible – semiconductors. All the four stocks representing the industry could be found among the sci-tech board's top performers now.
AMEC (Advanced Micro-Fabrication Equipment Inc China), Anji (Anji Microelectronics Technology Shanghai Co Ltd), Espressif (Espressif Systems Shanghai Co Ltd) and Montage (Montage Technology Group Ltd) had been in good standing well before the new platform started trading on July 22. All their offering P/E ratios were above 40.02 – market average on ChiNext, another China's Nasdaq-style board, let alone AMEC's (688012:SH) record-high 170.75.
Wild market ingested chunks of stocks put up for sale by the primary investors. According to the Shanghai Stock Exchange, more than 50% of organizations that obtained share allocations during the 25 public offerings happened earlier this month sold their stakes on the first day of trading.
Three open trading sessions turned to be enough for the initial craze to cool down and come to the delicate equilibrium. On Tuesday, volatility dropped; it didn't fade away, though. According to EqualOcean's evaluation, the second phase (post-psi) of the new venue's evolution process started in the afternoon trading session, July 23. From this time on, market players began to be less spontaneous in their decisions.
Anji Technology (688019:SH) remained to be an object of market speculation in the post-psi phase; however, it became almost three times less volatile. Espressif Systems (688018:SH), a WiFi chipset producer, also slightly reduced the density of fluctuations, staying vulnerable to dodgy public decisions. In general, semiconductor companies' stocks have been growing actively throughout this week.
For a small (255 employees as of 2018) Montage Technology (688008:SH), which collected a revenue of USD 1 million per employee last year, this boost brings a reason to be rightly called a mid-sized chipmaker. Its recent stellar financial performance (for one, net profit margin of 41.2% was recorded in 2018) positively affected the stock price. The other three firms have also been reporting profits since 2016.
Worth noting that all the "Star chipmakers" are Shanghai-based, their combined market capitalization climbed up 186% from CNY 50.63 billion (USD 7.36 billion) to CNY 144.86 billion (USD 21.06 billion) within last week. Although this isn’t an exception as all the stocks on the Star board have surged remarkably, there are some reasons why chipmakers gain more attention than other outperformers.
"Current lofty valuation of semiconductor stocks on the Star Market is reasonable: investors of all types are positive about this industry in China."
Wang Liming, executive director of CICC
The four firms mentioned all are strong industry players having distinctive competitive advantages at certain stages of various value chains. Nonetheless, their "chipmaking identity" is a critical factor in the market assessment. This statement was approved last week as the SSE sci-tech board started trading.
EqualOcean undertook a systematic approach in dissecting the situation around the design and fabrication of semiconductor devices and microelectronics businesses.
According to McKinsey estimation, semiconductor companies so far obtained less than 30% and 20% of the value coming with technology stack in PC and mobile areas respectively. At the same time, software developers grabbed a more significant hunk. The consultancy bets that this proportion will flip over in the near future, facing chipmakers taking home up to 50% of the technology stack-related cash. Why?
Most of the major forces swaying the semiconductor sector in China nowadays can be broken up into five groups by a scale in time: "global zeitgeist", "local zeitgeist", "state strategy and policy", "geopolitical tensions" and "industrial landscape". Some of the categories mentioned are unwrapped below.
Connectivity, a truly monstrous trend, has become a major game-changing wave globally at various levels from household IoT (Internet of Things) to global communication and transportation. Last year, Bain&Company estimated that worldwide IoT market size will hit USD 520 billion by 2021. The so-called "digital transformation" further accelerates the ubiquitous IoT adaptation process.
Tech improvement and sustainability needs are paving the road to more environment-friendly methods of transportation. Besides, car makers have lately been involved in newly emerged battlefields of the non-price competition. Striving to enhance road traffic safety -- the realm seeing most vicious market rivalry today, -- they spur the rapid growth in global sales of automotive semiconductors.
Besides global zeitgeist
Surely, planetwide trends do shape investors' expectations. There are some issues that are special about China in this regard though. IIot (Industrial Internet of Things) is hot this year not only in tech media but in business circles as well. As the overall quality of goods produced by the "World's Factory" improves, local companies look for smarter ways to organize the manufacturing process. Even at the micro-level.
Why China is a promising market for household appliances is beyond question. And IoT goes hard therein recently. Local tech giants like long-suffering Huawei and "young and passionate" Xiaomi (01810.HK) are actively restructuring the product mix in order to reap the fruits from the country's growing middle class.
The world's largest passenger car market is where fierce competition between producers in the automotive industry happens. In recent years, we have experienced a boom of EV (electric vehicles) sector that was sparked by various objective and subjective factors (read here about how and why EV industry was sprung up in China). Autonomous driving also contributes to the burgeoning but brutal auto scene. And this is where microelectronics is pivotal.
Public security has been a viral issue in China for a long time. The government maintains close ties with local private firms that position themselves as "AI companies". For example, closely followed by EqualOcean algorithm-developer SenseTime is among them. The public-private partnership segment in this industry got saturated in 2017, but a spacious room for deepening relations exists internationally (say, the famous Equador case).
No doubt that China, with its relatively nimble, progressive state-management model, bets big on the cutting-edge technology. Microdevices will become a core element in the country's near future, and chips are essential in any of those.
"The Chinese government has been supporting domestic semiconductor firms extensively and will continue doing that -- this is a long-term trend."
Bo Chunmin, senior analyst at EO Intelligence
The next dimension to put on the table is the current geopolitical backdrop. Numerous uncertainties evolved recently as the world shifted from the organization-based to the agreement-based model. While the global division of labor is being staggered by irrational and spontaneous political decisions, countries have no choice but to prepare for the worst. China isn't willing to suddenly find itself in zugzwang; the government thereby makes changes accordingly.
Supply chains become shorter and more localized. Ecosystems, being exposed to spillover effect and "liquid" innovation, expand rapidly. Accounting for up to 90% of the worldwide smartphone supply, China still imports core components.
Huge space exists in the industry, and a broad gamut of investors from state-backed organizations such as CICIIF (China Integrated Circuit Industry Investment Fund) to venture capitalists want to participate and frame the new technological revolution.
Successful IPO is a critical milestone for the nascent Chinese semiconductor companies. Their current valuation and low volatility rates validate the market's trust that is originated from three converging pillars: global connectivity trends, the industry's strategic status in the country and their splendid financial performance.
EqualOcean considers chipmakers' stocks as the least fragile among those on the Shanghai Stock Exchange Star Market to date.